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By Comstock Partners:

The Greek credit crisis is just a symptom of world-wide credit problems that was signaled by the emergence of subprime loan disclosures as early as August 2006.  The importance of subprime lending problems and its subsequent disastrous effects on the global economic and financial system was not recognized until much later, but nevertheless evolved into a continuing series of economic and financial crises that persist until this day.  The problem has now extended to sovereign debt, and, as usual, the weakest links (Dubai and Greece) are exposed first, only to potentially spread to stronger entities later.  Not far behind are Portugal and Spain, whose credit ratings have been significantly lowered this week.   It’s not just a localized crisis to be solved by some sleight-of-hand by the EU and IMF, but a debt crisis that has the potential to envelop the globe.  Since the onset of what started as a subprime problem, private debt has been shifted to government debt, and now stronger governments are attempting to bail out weaker governments with even more debt.  Eventually, this will place the stronger governments in jeopardy as well, and what happens then?

In addition to excessive fiscal deficits by some of its weaker members, the EU has some special problems for which there are no good options.  The Greek government can either undertake severe fiscal austerity measures, default, be bailed out by the EU, or leave the organization entirely.  Each of these has dire unwanted consequences.  The result of enough fiscal austerity to relieve debt pressures is a severe recession or, more likely, a depression.  An independent nation that is not a member of a multi-national group generally offsets these measures with an easy monetary policy and currency devaluation, something that Greece cannot do as an EU member, since they do not run an independent monetary policy and share a common currency.  Default would cause havoc in the EU banking system that holds most of Greece’s debt.  An EU bailout, which now seems the likely outcome, would only push off the crisis since other weak members would soon demand a similar deal.  While the Greek economy is relatively small, and the Portuguese economy slightly smaller, bailing out an economy the size of Spain’s would be an enormous, if not impossible undertaking.  And leaving the EU would probably bring down the organization.

Furthermore Greece’s debt burden is only slightly more onerous than those of a number of other countries including the aforementioned Portugal and Spain as well as Italy, Ireland, Iceland and Great Britain.  Globally assets soared in price during the boom, supported by vast increases in debt.  Now the assets are severely diminished while the debts remain, and there is insufficient income to pay them off and difficulty even rolling them over.  Thus, the world is dealing with an insolvency crisis rather than a more manageable liquidity crisis.

As we write the German parliament is considering, and will probably pass, an authorization of 8.5 billion euros to bail out Greece as part of an overall 45 billion euro EU and IMF package.  At the same time the EU and IMF are attempting to coordinate a 120 billion euro package with contributions from the EU and IMF.  Yes, it seems the price of the rescue keeps moving up as we write.  Goldman estimates the cost of meeting Greece’s needs over the next three years at $150 billion euros.  Even scarier, J.P. Morgan Chase is reportedly estimating the cost of bailing out the EU’s southern tier at 794 billion euros!  It seems to us that no group of nations would be willing to tax their citizens enough to come up with that great a sum.

In our view investors are making a big mistake if they think the EU and IMF can paper over this vast problem with yet another bailout that only adds to global debt rather than reducing it.  It is also misleading to believe that Greece is too small and unimportant to matter, and that, somehow, the rest of the world is isolated from the turmoil.  Greece is to sovereign debt what subprime was to private debt.  It’s the possible start of a vast tsunami that threatens to overwhelm the global economic and financial system. Although investors may breath a sigh of relief every time a bailout is announced, the sense of relief can only last until the next debt crisis pops up.

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