In the hours after Greek citizens voted NO to more austerity, the two most frequently asked questions that I fielded were: (1) What’s next? (2) What should investors do? Five years ago, the European Central Bank (ECB), the European Commission (EC) and the International Monetary Fund (IMF) funneled billions into Greece not out of the kindness of their hearts, but to provide a backdoor bailout to its own financial institutions, which had lent Greece gobs of money over the previous decade. If Greece had defaulted then, it could have taken down the entire European banking system.
Five years later, with banks back on their feet and the European economy strengthening, Euro group leaders assumed a tougher negotiation stance on the restructuring of Greek debt. In order to unlock about $8B of much needed rescue funds, Europeans said that Greece must agree to more taxes and an increase in employee pension contributions (“austerity”).
Greece’s Prime Minister Alexis Tsipras called for a national referendum, where Greek citizens voted on the euro group’s demands, which he believed were draconian. The ECB subsequently turned off the spigots, leaving Greece without a lifeline and forced the closure of banks and the imposition of capital controls, limiting Greek citizens to withdrawals of $67 per day. Not surprisingly, the country missed a $1.73B payment to the IMF, putting it into a dubious club that includes Cuba, Zimbabwe and Somalia.
When Greeks overwhelming voted NO on the referendum (61.3%), it armed Tsipiris with a mandate, which essentially said, “austerity has hurt the Greek economy (GDP has contracted by 25% in the past five years) and caused widespread suffering (25% unemployment overall and 50% for the youth population). We want to stay in the euro zone, but we want a more humane deal.”
Now both sides return to the drawing board, trying to regain lost trust. The first step may have been the resignation of controversial finance minister Yanis Varoufakis, after Europeans indicated “a preference for his absence” when new negotiations begin.
But the hard work lies ahead. The Euro group’s total outstanding loan balance to Greece is $270B, a large chunk of which is keeping the Greek banking system afloat and the rest is in the form of longer-term Greek bonds, which require a $3.9B installment on July 20th.
If Greece misses that deadline, it would be in full-fledged default and the ECB would be hamstrung by its own rules: it can only lend to banks that are solvent and it’s hard to say that Greek banks are solvent if the government is not paying its bills. Without access to more money, Greece would have to issue temporary IOU’s to its creditors. Ultimately, it may be forced to create a new currency, which would mean a widespread devaluation of whatever money is left in the Greek banking system and a lot more suffering for Greeks.
While a deal between Greece and its creditors may finally emerge, it would likely just kick the can down the road. Economists say the real solution is simple, but not easy: the Europeans must admit that they will never get all of their money back and write down the loans by half. Doing so will allow Greece to emerge from the crisis on firmer footing. The alternative would be a Greek exit from the euro zone and a 100 percent write down.
Now to the second question: What should investors do?
Sit still and do nothing. Be disciplined and stick to your game plan and don’t try to guess the next move up or down in the markets. In fact, if you are still contributing to your retirement account, you should be rooting for a further sell-off so you can buy shares at lower levels! If you are retired, you were hopefully wise enough to create a balanced portfolio that limits market volatility.