JPMorgan Estimates Immediate Losses From Greek Exit Could Reach 400 Billion

While our earlier discussion of the implications of Greece's exit from the Euro are critical reading to comprehend the real-time game of chicken occurring in front of our eyes, JPMorgan's somewhat more quantifiable estimates of the costs and contagion, given the results of the Greek election have raised market expectations of an exit of Greece from the Euro, also provide key indicators and flows that should be monitored. Identifying what has gone wrong with Greece's co-called 'adjustment' program, they go on to identify key transmission mechanisms to Spain and Italy, how it could potentially improve (Marshall-Plan-esque) and most critically, given the exponentially growing TARGET2 balances, if and when Germany throws in the towel.

JPMorgan: Greek Contagion

The results of the Greek election have raised market expectations of an exit of Greece from EMU. How exactly could this exit happen and what flows should we monitor?


Market forces could induce a Greek exit. A potential deadlock between the Greek government and the Troika which terminates funding from the EU/IMF, has the potential to create fear and panic and accelerate the capital and deposit flight out of Greece. Once this capital flight accelerates Greece would likely have to ultimately introduce capital controls. With EU funding being cut and the economic situation deteriorating, Greece will likely to start paying at least part of salaries and pensions in promissory notes or Greek bonds.






Unfortunately, we need to wait until the end of June for the ECB’s monthly MFI balance sheet data to get an accurate picture of the impact of Greek elections on deposits. Anecdotal evidence from the Greek press and elsewhere suggests that deposit outflows re-accelerated post elections.


It is often stated that Greece’s low primary deficit (projected at 1% or €2bn in 2012) increases the incentive for Greece to walk away from the bailout agreement. This is not true, in our view, given that Greece is still on the hook for the €6.3bn that is needed to clear general government arrears and the extra €23bn that is needed to complete the bank recapitalization plan. And as described above, a deadlock with Troika raises the risk of an accident that leads to Greece’s departure via market forces even if this was not the original intention of the Greek government.



What would the consequences for the rest likely to be?






What has gone wrong with the Greek adjustment program?

After all, Greece has managed to reduce its primary deficit by 8 percentage points in two years, something that no other country has achieved. And according to Bank of Greece, given announced cuts, unit labour costs are likely to be down by 13% this year vs. the end of 2009, an adjustment that is only comparable to Ireland’s “success” story. From a technocrat’s point of view, this must be impressive performance.


Perhaps the best way to understand what went wrong with the Greek adjustment program is to compare it with Iceland’s program. On Nov 3rd 2011, the IMF issued the verdict on its 3-year adjustment program for Iceland. The IMF’s verdict was that its “program for Iceland was a success” due to 4 factors:

  1. the decision not to make taxpayers liable for bank losses.
  2. the decision not to tighten fiscal policy during the first year of the IMF program.
  3. preservation and even strengthening of Iceland’s welfare state during the crisis.
  4. prudent use of capital controls. The IMF said: “capital controls were necessary and are now seen as useful addition to policy toolkit”.

Although permissible under EU treaties, factor 4 is admittedly not consistent with a monetary union. But none of the remaining 3 factors were present in the Greek program. No debt relief was given to Greece early, the fiscal adjustment was front-loaded rather than back-loaded (a massive 5% deficit reduction was required in the first year only), and not much attention was paid to protecting those at the low end of the income distribution.

How could the situation improve?

The Marshall plan for Greece is probably the best hope. Much has been said about Greece’s Marshall plan over the past months but little has been done. Estimates are close to €20bn or 10% of Greek GDP. Assuming Greece is changing its bureaucrat and deficient administrative/tax/legal structures quickly enough to allow for fast absorption of these funds, a Marshall plan has the potential to at least stop and perhaps reverse the economic decline.




Clearly such a Marshall plan represents a transfer from the core to periphery. These transfers are necessary in a monetary union where the core diverges from the periphery or, more correctly, Germany diverges from all the rest. Charts 2 and 3 show that both TARGET2 imbalances and real GDP levels continue to show a widening gap between Germany and the rest.


Without these transfers the likelihood of repeated crisis in the euro area will remain very high especially if tight financial conditions, uncertainty and lack of private sector investment condemns the periphery to a path of rising unemployment and never ending economic decline. And unfortunately Greece is not alone in facing these persistent headwinds. As we highlighted in F&L April 27th, the drag from tight financial conditions on periphery remains heavily negative.


It is possible that necessary fiscal transfers are not politically feasible or that Germany is eventually far too different from the rest to coexist in a monetary union. In this case the horrific scenario of a break up becomes more likely. We would like to make two observations: 1) it is less painful and makes more economic sense for Germany rather than periphery to leave. See above discussion on consequences of a Greek exit for Greece, 2) the cost of a breakup is rising exponentially over time. Bundesbank TARGET2 balance reached a new high of €644bn in April.