Let Greece default on its debtLet Greece default on its debt

 
Jon Markman's Speculations
Commentary: Painful actions now could pay off later for investors

 Jon Markman's Speculations

 NEW YORK (MarketWatch) -- The Greek debt fiasco could end surprisingly well for investors on both sides of the Atlantic.

If you sense there's a catch, you are right. The best way out of this mess is for Greece to man up to its deficit problems by defaulting on its sovereign bonds, withdrawing from the European monetary union, reviving and devaluing the drachma, and beginning the financial equivalent of a twelve-step program to cure its debt addiction.

NEW YORK (MarketWatch) -- The Greek debt fiasco could end surprisingly well for investors on both sides of the Atlantic.

While that result might sound bad for investors, it really isn't. As long as Greek debt holders receive some reasonable return of capital in the process, as I suspect they would, they can move on from this mistake to invest in other distressed but not doomed credits with greater potential for return. Read about Greece, Portugal debt downgrades.

Then they can turn the page on this unfortunate chapter in financial history, much like General Motors and Chrysler debt holders did in the United States in March 2009, and it will be game on for an expansion of the global credit and equity bull market.

As WJB Capital Group credit analyst Brian Reynolds often points out, it's not the quality of debt that matters, it's the quality of debt holders. Credit busts do not emerge as a result of borrowers' actions, but rather when overleveraged credit owners are forced to sell for big losses. Conversely, credit booms arise when debt investors are willing and able to purchase new distressed bonds after occasionally accepting small losses on minor holdings.
If you sense there's a catch, you are right. The best way out of this mess is for Greece to man up to its deficit problems by defaulting on its sovereign bonds, withdrawing from the European monetary union, reviving and devaluing the drachma, and beginning the financial equivalent of a twelve-step program to cure its debt addiction.

No one to take credit

Last year around this time, the global credit and equity boom kicked off when U.S. auto company debt holders were able to exit their obligations with barely a scratch following a government compromise that was long in coming. They moved on to buy distressed bank and industrial credit at massive discounts from which they were ultimately able to reap fantastic gains. The positive effects of this chain of events are still powering the current rally.

The problem with this scenario transpiring in Europe now is that it depends on a few bad actors finally doing the right thing.

Start with the top European politicians. German and French leaders Angela Merkel and Nicolas Sarkozy have been highly reactive to the Greek crisis, and have only managed to forge a series of bad compromises that have split and angered their electorates. Each time that they issue a joint communiqué expressing support we have seen their views undermined by contradictory statements back home. That undermines investor confidence that a lasting solution can be arranged. Read commentary on euro zone's demise.

EU leaders must find the courage to lose a little face and simply let Greece out of its crippling euro obligation. Like the great political philosopher Sting once said, "If you love someone, set them free."

Next are the Greek politicians. They must stand before the world and acknowledge that they can't pay back their debts, now or in the future from new borrowings, and declare the sovereign equivalent of bankruptcy. The longer they delay, the more that bond vigilantes will force their hand via antisocial activities like selling the debt and purchasing credit default swaps, which have the effect of forcing up interest payments and exacerbating the country's fiscal strain. Read about Greek central banker's call for spending cuts.

Rough road, but a recovery

Greece needs to recognize that default is not the end of the world. The sun will keep shining over the Aegean. Plenty of countries have done it over the past few centuries without incurring the long-term wrath of markets. Worriers always point to the highly negative consequences that transpired when Argentina defaulted in 2002, as Buenos Aires became a pariah shut out from international credit markets. The default led to the loss of a 1:1 currency peg between the Argentina peso and the U.S. dollar that resulted in a quick devaluation, and that in turn generated horrific domestic inflation and crushed the nation's debt-fueled prosperity.

But Argentina was an extreme example of default pain. Argentine debt holders received only around 35 cents on the dollar, while credit experts tell me that Greek debt holders would do a lot better, receiving 70 to 75 cents on the dollar. See full story on turmoil in Greek stock market.

And if Greece were to launch a devaluation and economic austerity plan similar to the one enacted by Boris Yeltsin in Russia following Moscow's default in 1998, authorities believe that it could return to international debt markets in just a couple of years. If they allowed counterparties to exchange Greek euro notes for much cheaper drachmas, they could give their export businesses a huge boost, draw in tens of thousands more tourists, and create an economy in which foreign risk-takers would want to invest by the middle of the decade. Read about euro weakness, U.S. dollar strength, in wake of Greek debt crisis.

The Greek politicians would squawk that they couldn't borrow. But for Athens not to borrow is not such a bad thing. "They need to wean themselves off debt," said credit derivatives expert Satyajit Das in an interview.

If the Greeks try instead to survive off EU and International Monetary Fund loan guarantees, analysts believe they will find itself in the impossible situation of needing up to $25 billion a year more every year. That would require leaders to slash the number of public jobs and infrastructure by more than half, shrinking the economy and withering tax revenues down to a fraction of current levels.

That approach creates what academics call a "debt spiral," a lethal condition that could lead to civil unrest, impoverishment of the middle class, extreme instability and a contagion that could imperil Europe. Ultimately the EU will realize it's a lost cause and expel Greece when it's too late.

In short, it's time for all parties to accept the mistakes of the past, stop sharing needles like debt junkies, and move on. It won't be easy to do it now, but it'll be harder to do later.

If you want to speculate on the potential for this to occur, it's a little early yet to buy European stocks or debt in large quantities. But if you're patient, the governments with the best credit, fiscal soundness and opportunity for leadership are in Vienna and Stockholm. The exchange traded funds for those countries are iShares Austria /quotes/comstock/13*!ewo/quotes/nls/ewo (EWO 19.67, -1.00, -4.84%) and iShares Sweden /quotes/comstock/13*!ewd/quotes/nls/ewd (EWD 25.85, -1.34, -4.93%)

Jon Markman is a money manager and investment adviser in Seattle. He holds a position in iShares Austria. For more ideas, try a two-week trial to Markman's newsletter, Strategic Advantage ).