Oedipus Wrecks: Greek Elections and the Fate of the EU

by Enis June 13, 2012 2:13 pm • Commentary

The Greek elections this Sunday are a groundbreaking event because of their potential impact on the banking system in Europe.  The main reason why the Spanish bailout of $100 billion Euro occurred this past weekend was because the European authorities wanted to shore up the Spanish banks in case the Greek elections caused significant market uncertainty that risked a bank run in the rest of the region.  Current Intrade odds place a Greek exit from the Euro at around 40% by the end of 2012, which signals that most investors still expect the European authorities to bend to Greek demands to amend the bailout, no matter what they have said prior to the elections.

My view is that even if Syriza emerges as the winner, and looks to renegotiate the bailout, the Europeans will likely look to meet Syriza in the middle rather than force them out of the Eurozone altogether.  However, the problem for the Europeans is that the cost of the bailout bills are getting incrementally larger, as Spanish and now Italian 10 year bond yields are both over 6%.  As a result, each confidence-inducing action by policymakers needs to be incrementally larger (for example, a LTRO3 would likely have to be $1 trillion Euros to offer substantial market impact), which has increased the risk to both the ECB and European governments.

The European banking system is more than twice the size of the U.S. banking system in balance sheet terms (about $40 billion USD vs. $16 billion USD respectively).  Even more concerning, the European banks are much more leveraged than their American counterparts, shown by this chart from U.S. Trust:


With the European bank stocks still hovering less than 10% from 20 year lows, I feel quite negative about the prospect for risk assets over the next 3-6 months.  Until policymakers can somehow assure European bank depositors that their money will be safe, I expect the ongoing European bank run to continue, no matter the result of the Greek elections.