Deutsche's Three "What If" Scenarios: What Happens After The Grexit

Tyler Durden's picture

As reproted previously, the biggest event of the day will be the meeting between Greek PM Tsipras and Germany's Merkel, which - with Greece having only days of access to liquidity left (and a negative solvency position already as confirmed by Tsipras' letter to Merkel saying it will be unable to repay its near-term debts) - means the fate of Greece will be decided over next day, one way or another.

So while we await today's 6:00 PM GMT press conference, here is a "what if" analysis created by Deutsche Bank laying out three scenarios on the short and long-term consequences of a Grexit.

Here is Deutsche Bank

What if we are wrong? Grexit scenarios

We believe that ultimately, even at the cost of capital controls, Grexit will be avoided. But what if we are wrong? With the risk of Grexit, in our view the highest since the crisis began in late 2009 and European patience wearing thin, we engage in some “what if” analysis on the short and long-term consequences of Grexit under three scenarios.

Back in January we have looked at (i) channels of contagion, (ii) peripherals’ vulnerabilities and (ii) ex-post tools to contain contagion11. There we highlighted that in a Grexit scenario, direct channels are not the main source of concern. Indeed, the private sector direct exposure to Greece has been scaled down dramatically. It is the indirect channels that are by far more material.

Grexit Scenario 1: no contagion

In the first scenario, Grexit occurs but has no contagion effects thanks to the QE firewell and the perception that Grexit is due to an idiosyncratic event mainly caused by the Greek government. No contagion implies that the shortterm implications for the stability of the euro-area are benign.

However, despite the benign short term impact, we think that the stability of the euro-area would be weakened in the medium to long term because membership of the euro area could no longer be considered permanent. A political accident could occur again.

Investors would have to assign a non-zero probability to redenomination risk for other weaker counties too. This is not necessarily something the market prices immediately. But the next time the euro area faces a (tough) recession or a member state suffers a shock or its politics turns more populist, risk premia would likely rise more quickly than if Grexit had not happened. In short, the euro area could be rendered systemically more vulnerable by Grexit.

Back in January, to quantify the impact of redenomination risk, we look at a representative country with public debt of 115% of GDP, 3% nominal growth and an average cost of debt of 3.5%. This government would need a primary surplus of about 0.5% of GDP to stabilize its public debt.

Figure 7 provides a number of probability-depreciation combinations. The depreciation of the new Greek drachma would be taken as a reference point. We think that a 50% nominal exchange rate depreciation is a reasonable starting point. Were investors to assign a 5% probability to a 50% depreciation within one year, the debt-stabilising primary surplus would jump to about 4%. Such a primary surplus  is proving political undeliverable in Greece and in general tends to be achievable only in a strong recovery.

Grexit Scenario 2: contagion

Markets have proven benign around the stress points during the Greek saga probably expecting a noisy journey but ultimately a compromise.

Still, Grexit could create some modest contagion. In our Scenario 2, therefore, following Grexit there would be an increase in volatility and a negative market reaction, including a widening of peripheral government spreads, a flight to quality in the bond market, weaker equities and weak risk markets in general.

However, we also believe current buffers and backstops will catch markets before a self-sustaining negative feedback loop takes. This may require some demonstration of the capacities of the euro crisis firewall, for example, an accelerated pace of QE, easier access to the TLTRO liquidity, revised terms and conditions on the official loan programmes, etc.

Still, under Scenario 2 as under Scenario 1, we think the euro area would be more vulnerable post-Grexit when the next crisis materializes: the precedent of exit will have been created by Greece and the euro area will be systemically more susceptible to loses of confidence in weak member states as a result.

Grexit Scenario 3: a stronger monetary union

In Scenario 3 euro area leaders understand that Grexit destroys the argument that membership in the euro area must be considered permanent. Investors will no longer be able to assign a zero probability that a similar political mistake will not happen again during the next crisis. The rise of populist parties across the euro area reinforces the risk.

Euro area leaders might be tempted to make an example of Greece – shutting out the country from the EU and making its exit as painful as possible. Even Bedsides geopolitical considerations, we do not think this is the best option. In “The Prince”, Machiavelli never wrote that the end justifies the means. His message was that a kingdom founded on fear is intrinsically unstable.

In Scenario 3, euro area leaders, conscious of threat to lasting stability, decide to take a major leap forward in the integration of the euro-area regardless of the short-term degree of contagion. This could take the form of stronger macro-economic coordination – i.e., surrendering more national sovereignty – in exchange of greater federal funding via issuance of euro-area federal bonds.

Such a major leap in integration would strengthen the stability of the monetary union. EMU membership would bring fiscal advantages as long as rules are respected. The Greek example and the greater coordination would make easier to motivate structural reforms. EMU could then become less imperfect.

Conclusions from our “what if” Grexit scenarios

Of the three scenarios, the most efficient ex-post response from euro-area partners is the one in Scenario 3 – further integration. Indeed, were this intention to be signaled unambiguously before Grexit, it would credibly confirm that the euro-area partners are not bluffing in their unwillingness to incur any costs to avoid Grexit. An excessive compromise with SYRIZA, above all in terms of structural reforms, will not be accepted. This would, in turn, increase both the ex-ante credibility of the Eurogroup’s message to Greece and the benefits of remaining in the euro-area while following its rules. Hence, ultimately, the forward-looking implementation of Scenario 3 would reduce the likelihood of Grexit.

Unfortunately, we think that Scenario 3 is the least likely. It is potentially feasible only if market pressure increases exponentially, that is, if the current backstops including QE comprehensively fail. Even then, the rise in populism throughout the euro area, in the core as well as the periphery, questions whether a consensus could be reached on closer integration.

Whether Scenario 1 (no contagion) or 2 (contagion) is most likely depends on market perceptions of two factors:

  • Politics: The more the market views a Greek exit as an idiosyncratic event related to Greek specific issues, the less likely will be contagion. Rising populism in the periphery could gives rise to a channel for contagion.
  • ECB: The less the ECB is concerned about moral hazard, the better. The lack of opposition from the ECJ Advocate General to OMT and the capacity of the ECB to deliver a QE policy above elevated expectations increased market confidence in the central bank. To protect the independence of ECB policy, it is imperative that the fiscal/non-fiscal policy coordination framework operates. For the framework to be binding there needs to be political will to enforce policy recommendations. This can be questioned.

Overall, there is a good chance that Grexit would be seen as idiosyncratic. We recently reviewed the political situation within the other peripherals holding elections over the next year. It is possible that the perception of Syriza’s policy success or failure in Greece damages support for anti-austerity and populist parties elsewhere. The good news is that we think it is extremely unlikely that Podemos will obtain an outright majority even if helped by small parties, although by taking a large block of votes increases the challenge of creating a stable government. In Portugal and Ireland, anti-austerity rhetoric is audible, but we expect broad policy continuity.

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GMadScientist's picture

Contagion: Yes Stability: Stronger

Hahahaha. Let it burn you 'integrating' Zooropean morons!

GoldSilverBitcoinBug's picture

The first chart (Figure6) is about how to explain what it's the twilight zone...

KnuckleDragger-X's picture

They have a secret plan to win the war........

Herodotus's picture

Wishful thinking.

4th scenario - Greece exits, DB goes bust.

gmrpeabody's picture

QE was designed to bail DB out...

FreeMoney's picture

Yeah no kidding.  QE in Japan, the UK and the US has only to been to allow the banks and insurance companies to dump their toxic loans on the central banks....the problem is that the banks have now loaded up on sovereign debt and currency carry trades and those "assets" are also proving toxic.  What I can figure out is how much bigger they can blow this bubble before it pops...

...out of space's picture

yep, what grexit?

look how greeks gov. play a long with trojka, they just robb greek pensioner fund. 

its a big club and we ar not in. geogre carlin

Anasteus's picture

Just a few remarks on top of the optimistic first 'no contagion' (and, in fact, also in dysfunctional monetary union in the third) scenario; after Grexit, Greece will have to restart drachma and to seek closer financial/business relations with other countries, out of which Russia is the first and the hottest candidate. After initial difficulties (which indeed can be hard in the beginning) Greece will eventually consolidate to some sustainable extent and will continue deepening the Greece-Russia relations. Even if a member of the NATO, sooner or later Greece will eventually have to surrender some areas to satisfy Russian military zone requirements in return for financial aid. After then Greece will be more or less consolidated with strong ties to Russia (China, Brazil, India, etc.) and with the former European debt effectively written off, on her path to a sustainable, though slow, prosperity.

Although Greece will certainly have to get over hard times to manage it all, it will then serve as a template for other countries in Europe. So if Spain and Portugal want to throw in the towel and get rid of their debts, a list of exact steps what to do will already be collected and tested.

kaiserhoff's picture

What happens next?

The whole shit storm moves to Italy and Iberia.

Easy call.

ANestIOS's picture

is this the same failed stress test Deutsche? The analysis above is shockingly shallow

p00k1e's picture

A nuclear war would sweep all of this under the carpet. 

Coke and Hookers's picture

Scenario 3 is only interesting from a psychological point of view, particularly for those who study groupthink, brainwashing and delusional thinking.

Amish Hacker's picture

Sometimes I think that half the mischief in this world is caused by people who like to say, "ex-post."

Youri Carma's picture

Letting Deutsche tell you what happens after a GREXIT is like the fox guarding the henhouse. They are acting as gatekeepers here. Did they tell you about the $4 trillion derivatives bomb blowing up?

williambanzai7's picture

Next Chart: Bailout Scenarios following GREXIT Contagion

taketheredpill's picture



So..Worst Case is "Minor Impact" / "More Fragile".  Thank you for calming me down.  Can I buy European Bank stocks and peripheral Sovereign debt from you?


BadKiTTy's picture

Where is the 'Grexit, increasing instability, Douche Bank derivatives blow to feck, bail ins for depositors' option? 

Ulterior's picture

The sooner the better, any scenario is OK

basho's picture

do people actually get paid for concocting BS scenarios like this?

current tools are not working, haven't been working. won't be working. FU rothschuld.

strengthening integration? what does that mean turn europe into a police state?

if greece goes it's going to be a race to get out. Spain, Port, Ireland

UK is already out according to them.

Hungary, Austria will look east

DE will beg Putin for a good word to get into the eurasian group. so will FR. LaPen wants out now anyway.

mutti merkle is out. der spiegel fired the first shot with its latest cover.

the Baltics and the Poles will join the ussa lmao

UE wil be subdivided into 3 states

integration, my *ss. lol

Jano's picture

The answer to your question:


tsuki's picture

The March report by the Bundesbank says the EU is running out of air.  That they see little chance of a more integration or a political union.  Says that the EU needs to start making plans how to handle state bankruptcies.

NoTTD's picture

What load of shit.

adonisdemilo's picture

I can't imagine a bigger bunch of losers who I'd like to see on the unemployed, and unemployable, lists than the current crop of know-all-fuck-all politicianns and banksters who think they have Europe "under control".

Jano's picture

today or tomorrow is the solution on the table?

Because there is no money left?

A white knight will come in the last moment....

123dobryden's picture

i like this scenario better "all greece government workers are fired with 400e pension" scenario 

Al Tinfoil's picture

The "Grexit Scenarios" chart looks like an official announcement in a train station of a slow-motion train wreck. Sorta like: "Keep calm as the wreckage piles up".