February 2018
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Your Bank Bought Subprime Loans. How About Greek Bonds?

What might happen can matter more that whether it will happen.

The potential gain from snatching up pennies from in front of a steamroller seems less attractive when you consider the potential loss. Risk management is likewise often more effective if we look at the potential effects of an event than whether or not the event will occur. The important question is often not will it happen, but can it happen and what will it mean?

Take Greece as an example. Assume for a moment that the Greeks default on their debt. What will this mean? Think bankruptcy. Everyone that Greece owes money will have to line up to see how much they get back. General Motors ought to serve as a warning of how political this process can get. Resolution can drag out and the bondholders may not to get paid anything any time soon.

The bondholders are obviously not in a good position. Whether their money is all gone or partially gone, it is definitely inaccessible. The Greek bonds cannot be traded at anything like their regular value and are in effect frozen. This means the banks cannot use the money for anything else – like a loan to one of your suppliers or customers. Worse yet, who lent Greece the money? Your bank perhaps?

Who might be affected?

One of the parties in the current Goldman Sachs case is the German IKB bank. Their normal line of business is lending to small and medium-sized innovative growth companies in Germany and Europe, but they decided to invest in US subprime mortgages as well. What has your bank invested in? What have your business partners’ bankers invested in? Banks that lose money have less to lend. How vulnerable are you, your suppliers, and your customers?

Your bank may be in trouble even if they did not invest in Greece. Trouble can spread quickly. Portuguese debt was downgraded at the same time as the Greek debt. Spanish banks hold large amounts of Portuguese bonds – and Spain’s rating dropped a day after Greece and Portugal were downgraded. What is their exposure to Portugal and Spain – or Italy?

Focus on the potential effects – and solutions

The key is that whether or not a default happens, the risk that it might happen is large, and the effects need to be analyzed. One of these might be a tightening of lending. This would affect firms adversely that, for example, rely on lines of credit or are in the midst of expanding – and they should examine alternatives. Can construction be delayed? Can staff be laid off easily or transferred to other work? Can suppliers extend credit? Can investors provide assistance?

Every dark cloud famously has a silver lining and risk can also present opportunities. European exporters may not have to worry about a strong Euro for a while to come – unless they rely on expensive imported inputs.

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