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98% chance of default over the next 5 years. Investors think this is almost certain doom for Greece:
1) The EU is running out of money (pull up Germany and France’s debt to GDP ratio over the past 2 years)

2) They are not proposing a sound austerity proposal

3) Voter sentiment against them is building in France and Germany

4) America is proposing a series of tax hikes that include municipal bonds: ie, they won’t be coming in the help Greece either, as they have plenty of problems themselves

5 years is a long time though, which justifies the investor sentiment of almost certain death. What about the short run though? For now, Merkel seems firmly behind Greece, meaning they will at least get a few more months of life injected into them. Though, at the current rate, Greece can only gain temporary life, and Germany can in no way sustain them for 5 years. Investors seem to be right on this one…

Until you consider the idea of a fiscal union. Look at German banks. Angela Merkel is not retreating for a reason: German banks have their funds locked up in Greek debt. Merkel will literally be self-destructing the German financial sector if she allows a Greek default.

This is a bit like China and the United States: China really wants their money, but if they force an American default, their economy will fall along with America. No leader in the right mind will allow their country to fall in such a mushroom cloud of financial disaster (save a few evil dictators).

I think the chances of a fiscal union are a bit more than 2%. This is actually the best chance ever the EU will get to have a reason for fiscal union. Crisis bring people together, and when both your heads are on the line, your irrational rage fades. It is replaced by rational sacrifice, as you suffer tax hikes to preserve not only a fellow European’s life, but your own life as well.

I do not see any quick way for the European banks to exit their position (who is going to buy out there?), and let’s assume Merkel would never allow the huge German financial sector to fall. Betting on a Greek default is beginning to seem synonymous with betting on the collapse of the German financial markets.

The chance of fiscal union, while probably still less likely than Germany finding away to let Greece die silently, is not merely 2%. I personally believe, that when you buy a security, you are not buying the “gains”, you are buying a “dream.” When you buy a share of Apple, you are buying Steve Job’s dream of forming a gigantic, closed ecosystem filled with magnificent iProducts. When you buy a treasury bond, you are buying the American dream of America being the most prosperous and stable (contrary to S&P belief)nation in the world.

When you are buying a Greek bond, you are once again remembering the European Union dream. After WWII, a time of turmoil and hyper-nationalism, people sought stability and peace. The idea of some form of an “European integration” sounded like the best hedge for a peaceful life. With it’s enlargement in 2004, all seemed well, as the Euro appreciated, and prosperity rained down on Europe. Now, that prosperity is in danger because of a few fiscally irresponsible nations.

When Angela Merkel said, “I have made my position very clear: that everything must be done to keep the euro area together politically, because we would very quickly face a domino effect”, she was defending her position because she had her nation’s interest in mind. Investors are right to believe that Greece will likely default in 5 years, because as soon as Germany has isolated themselves from the blast, they will cut Greece off.

But what about the realization of the dream? The dream of a peaceful and prosperous Europe? I think at this point in time, buying CDS on a Greek bond is equivalent to allowing the European dream die. Yes, the fiscally stable nations like Germany and France (if they properly isolate themselves) will live on, while PIGS explode over Europe, but the dream of the European Union being truly unified cannot be discounted to a low 2% either.

While political motion seems set in allowing Greece to die once Germany and France have established proper safety measures for their banks, the dream of a true fiscal union has the power to swing in quickly as well. If Germany and France are unable to isolate their banks, and a sudden swing of cooperation in hard times prevails in the harsh atmosphere, we may just see a new European Union emerge out of the pain and tears of the old one. This will be hard decision, but I believe the probability of realizing the European Union dream is much higher than a lowly 2%.

 

Extra note:

http://www.ft.com/intl/cms/s/0/9be75804-c3f7-11e0-b302-00144feabdc0.html#axzz1XqgQuoZf

Interesting supplement on the issue at hand

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