Henes: Are We Watching the Sequel to “Too Big to Fail?” Will Greece End Differently Than Lehman?
A friend of mine who runs a hedge fund likes to say, “I have seen this movie before, and I know how it ends…badly.” With respect to Greece, ironically, not only can we metaphorically say we’ve seen this movie before, but, in many ways, we have actually seen it - at least a movie of the same genre.
Many of us have watched HBO’s adaptation of Andrew Ross Sorkin’s superb book, “Too Big to Fail.” We all know the basic story. Lehman is on the verge of collapse. The government puts all of its eggs in one basket and attempts to broker a private solution to save Lehman. The private solution fails. The government, without a backup plan, lets Lehman fail. Lehman freefalls into bankruptcy, and the markets and economy implode.
The Greek movie (“Too Big to Fail; Too Big to Save”?) has different facts and different actors, but it may be of the same genre. It may be like a romantic comedy (only not romantic and not funny). All romantic comedies are the same, and we all know how they end. Boy meets girl. Boy falls in love. Girl takes off. Boy chases girl. Boy and girl fall in love. Boy and girl live happily ever after.
Romantic comedies take place in different cities and have different plots, but they follow the same pattern, and they end the same. Will the Greek movie follow the same story line as the Lehman movie? Do we already know how it ends? Based on the current circumstances, it looks like we may.
Greece has too much debt. As of April 26, 2011, Greece’s total outstanding debt was € 354.5 billion representing approximately 154% of Greece’s GDP. The ECB’s answer is to provide Greece with loans so it can make its bond payments in late June and, in exchange, Greece will implement austerity measures (cost cuts) and agree to sell certain public assets.
The Greek people do not like this and show their dislike through demonstrations, clashes with police and riots. The German government does not like this and supports a public/private sharing plan where bond holders take a haircut.
The bond market is trading as if a default and restructuring of Greek debt is inevitable with yields as high as 17.79 percent. And, as The Financial Times reported today, certain investors are making an “accident scenario” bet, buying one year CDS that pay out big money if Greece experiences a hard default in the next 12 months.
Have we seen this movie before? The bond market seems to believe it is watching the same cookie-cutter story and, therefore, knows the ending. The market seems to think that Greece will default - either in a few weeks or at later date because the ECB “bailout” plan won’t work.
Even with a bailout, Greece will be dangerously over-levered and, at some point, the politicians will decide that the public will not support more bailouts. Then, boom goes the dynamite, Greece defaults and the markets, which commonly were believed to have already factored in a complete default, turn to chaos as other nations and the banks holding Greek and other sovereign debt experience a financial crisis.
In the words of Nickelback, “Let’s rewrite an ending that fits/Instead of a Hollywood horror.” It’s time to change the story. The Lehman story could have ended differently, potentially without the chaos that ensued. If Lehman was given time to work with professionals to prepare for an orderly wind-down of its operations, things may have been bad, but a complete financial collapse may not have occurred.
To learn from Lehman, the ECB should not put all of its eggs in one basket. It should be prepared for a default and, therefore, be ready with a process to allow for negotiations to take place before the default occurs, with the goal being a comprehensive restructuring plan that will allow Greece and other peripheral European nations to cut their debt and live within their means without creating bank panics or market chaos.
The movie is still playing. We are all watching. Let’s hope we haven’t seen this movie before and let’s hope we don’t know how it ends.
Jon Henes is a partner in the restructuring group at Kirkland & Ellis LLP where he has led some of the most complex restructurings in the United States and abroad across a variety of industries, including media, chemicals, energy, manufacturing, real estate, retail and telecommunications. Jon has also frequently appeared on CNBC's "Worldwide Exchange" as a guest expert on various financial and economic topics, federal, state and local fiscal issues."