European Banks Exposure to Greece

As suggested in the chart below, French banks have the greatest collective exposure to Greece, holding nearly $79 billion of the country's bonds.  In second place are German banks with $45 billion of exposure.  As such, while the Eur30+ billion committment from the ECB is being couched as a "bailout" of Greece, a more appropriate characterization would be a bailout of the major French and German banks (hence my belief that a large rescue package is imminent).  Not coincidently, France has shown little resistance to the bailout.  In order to appease their rightfully angry citizens, German government officials have made a big public stink about the proposed bailout, but they too will eventually come around.

Given the absurdity of bailing out the profligate Greek government to save its own banks, one has to ask why the ECB doesn't just directly inject capital into the German and French banks who will undoubtedly be hurt most by a Greek debt default.  While the merits of this path should be explored, I suspect the ECB is concerned about the knock on effects that will undoubtedly spread to Portugal and Spain should they allow Greece to twist in the proverbial wind (particularly as Portugal and Spain have recently received downgrades from the major rating agencies).  By bailing out Greece, the ECB will send a message to foreign creditors that the region intends to stand by its members, thereby giving Portugal and Spain breathing room to get their own fiscal houses in order. 

While this may be the intention, I remain highly skeptical that Portugal and Spain (and eventually the UK) will avoid a similar fate as Greece.  With negative GDP growth forecasted for at least 2010, double digit budget deficits, and structurally high unemployment (particularly Spain which is approaching 20%!), it is only a matter of time before foreign creditors turn against both countries.  Most analysts suggest a bailout of the PIIGS could cost the European Central Bank 600 billion euros (~8% of the region's GDP).  Such a scenario would gravely impair the ECB's balance sheet rendering it an almost impossible solution.  While a bit premature, I think it is only a matter of time before a breakup of the EU begins to seep into the public dialogue.  The problem is simply too big and too widespread to fix in the absence of several large defaults. 

Ironically, I think the US will be the biggest short-term beneficiary of the contagion spreading in Europe.  While our long-term fiscal situation remains far from perfect, it certainly looks a lot better compared to the PIIGS!  Since capital has to go somewhere, much of it will likely find a home in the US.  With excess capital flooding into the US, real interest rates should remain low, helping to forestall our own day of reckoning.  I suppose this is the upside to Europe's woes, but it will only make the fallout from our own debt binge that much worse when the bill inevitably comes due.