An interesting starting point is to compare the impending Greek exit to the post-Lehman Brothers scenario. If we look at the differences, the fall of Lehman’s came as a shock because although it was common knowledge that it was in trouble during its final days, the general expectation was that they would be bailed out.
The fact they were allowed to go bust was a huge shock and it all happened very quickly and hence it caused the massive ramifications it did in the market with wholesale markets freezing up.
The difference this time is that this whole problem in the eurozone has been building up for at least two years so people have had time to adjust their positions to reflect the likelihood of a Greek exit from the euro. The question increasingly became when rather than if and clearly now it looks rather imminent. A lot of people who did have exposure to Greece would have either hedged it or simply sold it and have already taken the hit.
So Greece in itself defaulting, I don’t think will specifically cause that many more problems, certainly not to the UK banks. What will however be a problem is the knock on effects and what is much more difficult to identify is how big the contagion is going to be. If, for example, as a result of Greece leaving the euro people in Spain, Ireland, Portugal and a handful of other countries become increasingly nervous and start to realign their assets to reflect the likelihood one or more of those countries leaving the euro. That is then a far more serious problem.
It’s not just a question of the locals withdrawing their deposits. It’s the big money that might move away. It’s the wealthier people who might dispose of their local assets as they have investments elsewhere. People from Greece, Spain and Portugal might move to London as a way of getting their assets out of those countries.
In particular to the mortgage market, the most important question is going to be: how will wholesale markets react?
So far they’ve reacted surprisingly well. Three month LIBOR, which shot up after the Lehman’s debacle, has actually been edging down slightly over the past few months. It’s edged down from a peak of 1.09% in mid-January to currently 1.01% and even this week hasn’t shown any upward movement.
Because LIBOR is unsecured money, it’s particularly sensitive to banks being worried about other banks. I suspect the very short term reaction might not be too bad as a lot has been reflected in the markets, people have adjusted. If we get to the stage where, as far as the UK is concerned, Ireland defaults then that would be more serious for us than Spain defaulting.
If you look at the balance sheets of UK banks and where their assets are, most of them have deleveraged considerably in terms of Europe but some of them, Lloyds Banking Group in particular, have still got big exposure to Ireland.
If Ireland were to leave the euro, that would cause major problems. The other issue is that even though we don’t have exposure to Greece we do of course have exposure to banks who do have exposure to Greece. I would assume that UK banks who have got money on loan to continental banks will take a good look to establish how exposed they are.
The UK is one of the few countries that is still seen as a safe haven. The more troubles there are around the eurozone the more it’s likely that international investors will actually want to buy UK gilts. UK 10-year gilts are currently trading at 1.82% which is the all time low and obviously swap rates have come down as well. If you look at the way that bond yields are moving Italian, Spanish and Greek bond yields go up sharply and German and British yields go down.
There is a clear correlation there. The more people worry about these peripheral countries; they buy into countries that are perceived to be a safe haven. I don’t see why the Bank of England issuing more QE would change that. Theoretically the risk is it will generate inflation but we’ve had £325bn so far and there’s no evidence to see that it’s generating much inflation
