The Guest Blog

Henes: Are We Watching the Sequel to “Too Big to Fail?” Will Greece End Differently Than Lehman? Part II

Jonathan S. Henes|Partner, Kirkland HKSCKPVIamp; Ellis LLP

The sequel to “Too Big to Fail,” “Too Big to Fail, Too Big to Save” seems to be following the same tried and true Hollywood blockbuster movie formula. In “Too Big to Fail,” without a plan or a process, the government let Lehman fail and chaos ensued.

Here is the basic plot line:

Cut to a conference room. Treasury Secretary Henry Paulson, Fed Chairman Ben Bernanke and others are working on a plan to calm the markets and assure the survival of the banking system. They decide that the government should purchase up to $700 billion in mortgage-backed securities to provide liquidity and stabilize the banks. High fives all around.

Cut to a podium. The press is assembled. Treasury Secretary Paulson is standing tall. Paulson announces a tentative deal with the political leadership of both parties on a $700 billion bailout bill. Paulson says, “We have made great progress toward a deal, which will work and be effective in the marketplace.”

Cut to the White House. President George W. Bush expresses confidence that that bill will pass Congress.

Cut to a black screen with arrows going up. The DOW goes up 3 percent. More high fives. Smiles. Hugs. Back slapping.

Cut to the House of Representatives. The members are walking to the front, handing in their votes. Numbers start coming up on the screen. The House votes no - 205 for and 228 against.

Cut back to the conference room. Treasury Secretary Paulson, Fed Chairman Bernanke and others stare at the television in disbelief.

Cut to a black screen with arrows going down. The DOW drops more than 777 points. Chaos ensues. Paulson drops to his knees.

Cut to the House of Representatives. A new vote. The members walk to the front with their heads down, understanding that they misunderstood the gravity of the situation and the negative impact of their vote. Now, they vote in favor of the $700 billion bailout. The financial system is saved, but much of the damage was already done.

Now for the sequel—“Too Big to Fail, Too Big to Save.”

Cut to a conference room with members of the EU. One of the members: “I thought we had fixed Greece last spring with that enormous bailout. But here we are again. Greek debt comes due in July. Greece cannot access the capital markets. Its debt is more than 150% of GDP! Our initial bailout flopped. We threw money at Greece, and now we need to throw more money. Are the Greek bonds held by the ECB as collateral even worth anything? Alas. But, we can’t let Greece default. We need to lend them the necessary funds.”

Cut to a German reporter on the phone with a member of the German government. “So, Germany will not support a bailout without bondholders also feeling some pain? In other words, Germany believes that the Greek debt needs to be restructured?”

Cut to conference room with members of the EU. “If we don’t bailout Greece, and it defaults on its debt, the banking system is at risk. Greek banks will fail. French banks will fail. German banks will fail. Portugal, Ireland, Italy and Spain will all default. It will be Armageddon!”

Cut to a joint press conference with German Chancellor Angela Merkel and French President Nicolas Sarkozy. Merkel says, “The aim is the participation of the private sector on a voluntary basis, and the Vienna initiative, as it's known, is a good foundation, and I think we can move forward on this basis."

Cut to a conference room with members of the EU. “Germany is in!” High fives all around. Hugs. Back slapping.

Cut to traders: “Voluntary rollover?” Laughter. “Bailout?” More laughter.

Cut to a conference room at Fitch Ratings Agency. A Fitch analyst says, “A voluntary rollover of the Greek debt? What in the world are they thinking? A debt exchange or a voluntary deb rollover is a default event and would lead to the assignment of a default rating to Greece.”

Cut to a reporter typing on his computer. Words appear on the computer screen. "The EU will agree on June 19 to give Greece the funds already approved as part of last year's bailout." Applauds.

Cut to June 19 EU meeting. “We will give Greece loans, but only if it implements austerity measures. Greek Prime Minister George Papandreou must secure multi-party support for the austerity measures as a condition to receiving the bailout funds.”

Cut to Athens. The streets are on fire. The Athenians are violently opposed to austerity. The Greek government is in shambles. Papandreou replaces his finance minister and demands an emergency meeting of parliament to determine Greece's fate with a vote of confidence.

Cut to Greece's parliament. As the streets burn, the politicians debate. The European markets rise in expectation of Papandreou obtaining the necessary votes. The vote is scheduled for midnight in Greece.

That’s where we are in the sequel so far. What happens next? The audience is on the edge of their seats. But this is just the beginning.

Europe and its banking system face a financial crisis. Greece is overloaded with debt and will never - never - be able to grow its way out of it. When a country or a company has this type of debt problem, there is only one solution—reduce the debt. Slash it. Burn it. Get rid of it. But here slashing the debt will require thinly capitalized European banks to recognize losses. The EU would need to either bail out the banks or let them fail.

But how much money can the EU, the ECB or the IMF loan? And, what about the risks of contagion? Other European countries are overloaded with debt and European banks are holding that debt as well. With contagion can come another global banking crisis. The audience watches and pleads for the EU to see what's happening before it's too late.

Will the movie end the same as the others? Will the politicians focus on the impossible - saving Greece from a default for all time? Will they fail to develop a contingency plan, resulting in chaos, market failures and the need for a bank bailout? Or, will the politicians plan ahead, figure out a way to cut Greece’s debt and properly capitalize the banks in an orderly restructuring? Only time will tell, but I think we’ve seen the movie before and, I fear, we know how it ends

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.