The Greek Bluff In All Its Glory: Presenting The Grexit "Falling Dominoes"

Tyler Durden's picture

Earlier today, Yanis Varoufakis reiterated his core thesis driving the entire Greek approach from day 1 of its negotiations with the Eurogroup: "Europe [stands] to lose as much as Athens if the country is forced from the euro after a referendum on Sunday on bailout terms."

This is merely a recap of what we said 4 years ago when in July of 2011 we explained "How Euro Bailout #2 Could Cost Up To 56% Of German GDP", recall:

the bottom line is that for an enlarged EFSF (which is what its blank check expansion today provided) to be effective, it will need to cover Italy and Belgium. As AB says, "its firepower would have to rise to €1.45trn backed by a total of €1.7trn guarantees." And here is where the whole premise breaks down, if not from a financial standpoint, then certainly from a political one: "As the guarantees of the periphery including Italy are worthless, the Guarantee Germany would have to provide rises to €790bn or 32% of GDP." That's right: by not monetizing European debt on its books, the ECB has effectively left Germany holding the bag to the entire European bailout via the blank check SPV. The cost if things go wrong: a third of the country economic output, and the worst case scenario: a depression the likes of which Germany has not seen since the 1920-30s. Oh, and if France gets downgraded, Germany's pro rata share of funding the EFSF jumps to a mindboggling €1.385 trillion, or 56% of German GDP!

Several years later, in anticipation of precisely the predicament Europe finds itself today, the ECB did begin to monetize European debt, which has since become the biggest European risk-shock absorber of all, and the one which the ECB is literally betting the bank on: just count the number of times the ECB has sworn it has the tools and can offset any Greek risk contagion simply by buying bonds.

Unfortunately, it is not that simple.

The reason is precisely in the contagion threat inherent in Europe's alphabet soup of bailout mechanism as we explained four years ago in the post above, and as Carl Weinberg of High-Frequency Economics did hours ago in today's edition of Barrons. Here is how the Greek contagion would spread, laid out in all its simplicity, should there be a Grexit, an outcome which the ECB could catalyze as soon as Monday in case of a "No" vote by raising ELA collateral haircuts:

The [Greek] government appears ready to renege on its debt obligations. So Greece’s creditors are going to lose money—a lot of money. Since these creditors are public entities, the losses will be borne, initially, by the public.


This crisis is about managing the resolution of bad Greek assets in a way that inconveniences creditor governments the least, forcing the least net new public borrowing, and minimizing financial system risks. The best way to do that is to avert a hard default, even if it means kicking the can down the road.

That, once again, is the Varoufakis all-in gamble, a gamble which assumes the ECB will be rational enough (in a game theory context) to appreciate the fallout of a Grexit on Europe's creditors. Here is a qualitative determination:

Consider the ESM, Greece’s biggest creditor. Under its previous name, the European Financial Stability Facility, it loaned Greece €145 billion. If Greece defaults, the ESM, a Luxembourg corporation owned by the 19 European Monetary Union governments, will have to declare loans to Greece as nonperforming within 120 days. Accounting rules and regulators insist that financial institutions write off nonperforming assets in full, charging losses against reserves and hitting capital.


Here’s the rub: The ESM has no loan-loss contingency reserves. Its only assets—other than loans to Greece—are loans to Ireland and Portugal. Its liabilities are triple A-rated bonds sold to the public. How do you get a triple-A rating on a bond backed entirely by loans to junk-rated sovereign borrowers? Well, the governments guarantee the bonds, and because they are unfunded off-balance-sheet liabilities, they aren’t counted in their debt burdens—unless borrowers default.


If Greece defaults hard, governments will be on the hook for €145 billion in guarantees on those loans to the ESM. We expect credit-rating agencies to insist that these unfunded guarantees be funded. After all, unfunded guarantees are worthless guarantees.

And the punchline:

The strength of these guarantees is untested. Would the German Bundestag vote tomorrow to raise €35 billion by selling Bunds, the government debt, to cover Germany’s share of ESM losses on Greek bonds? That seems improbable. Bund sales of that scale, if they did occur, would flood the market, raising yields and depressing prices. If, instead, the Bundestag refused to cover its guarantees, then we would see a legal dust-up on a grand scale. With the presumption of valid guarantees, credit raters would have no choice but to downgrade ESM paper. Then losses would be borne by bondholders, and the ESM—the euro zone’s safety net and backstop—couldn’t raise money in the capital markets.

In other words, Grexit would usher in a pandemonium of unheard proportions because when the ESM, EFSF and countless other bailout mechanism were postulated, none even for a minute evaluated the scenario that is being flouted with ease, and, paradoxically, by the ECB itself most of all: an ECB which stands to lose the most...

A hard default would produce other losses to be covered. The ECB would have to be recapitalized after it writes off the €89 billion it has loaned the Greek banks to keep them liquid. The ECB would need to call for a capital contribution from its shareholders—the governments.

... not to mention any last shred of confidence it may have had.

But wait, there's more:

And don’t forget that Greek banks owe the Target2 bank clearinghouse, a key link in the interbank payment system, an estimated €100 billion. The governments are on the hook to make good that shortfall, too. The cash required to cover these contingencies would have to be funded with new bond sales.

The conclusion is incidentally, identical to what Zero Hedge said back in the summer of 2011: "the ultimate loser in a Greek default would be the euro-zone sovereign-bond market, which is already vulnerable. " The only difference is that this time, yields are near all-time lows, and durations are high. Ironically, even the smallest fluctuations in yield mean a volatile response in prices, and an immediate crippling of the bond market. Perhaps most ironic is that Europe's bond market is far less prepared to deal with Greek contagion now than when Italian bonds were blowing out and trading at 7%, just because everyone has double down and gone all-in that the ECB can contain the contagion. If it can't, it's very much game over.

This is what Varoufakis' likewise all-in gamble on the future of Greece boils down to.

And just so we have numbers to work with, here courtesy of Bawerk's fantastic summary, is a way to quantify what a Grexit and the resultant falling dominoes would look like for Europe:


Simplistic representation of falling dominos not enough? Then here is the full breakdown of implicit exposure every Euro Area country has toward a Greek exit, because it is not just the EFSF dominoes, it is also SMP, MRO, ELA, Target2, and oh my...

And tying it all together, here is some more from "Eugen von Böhm-Bawerk":

The Germans, French and IMF alike reluctantly admit so much, but they cannot give the Greeks any debt relief because as soon as Greece starts to default on their obligations on the off-balance sheet guarantees extended by the euro countries the whole system could fall like dominoes. 

The problem, however, is that the IMF already did admit that Greece does need at least a 30% haircut, implying that at least one member of the grand status quo, under pressure form the US, already got the tap on the shoulder and has been told to prepare for more falling dominoes. Which leads to even more questions:

What would happen if Italy suddenly got an extra funding requirement of more than €60bn? Every euro apologist point to Italy’s primary surplus, but what good does that do when your debt is over 130 per cent of GDP and rising? The interest payment on that gargantuan debt load means Italy must cough up more than €75bn a year just to service liabilities already incurred. A primary surplus is a useless concept in a situation like the one Italy finds itself in. Adding another €60bn to Italy’s balance sheet could very well be the straw that breaks the Italian camel.


The French would be on the hook for around €70bn just when they have agreed with the European Commission to “slash” spending to get within the Maastricht goal of 3 per cent, in 2017!


Imagine the German peoples wrath when they learn that Merkel defied their sacrosanct constitution; a constitution that clearly state that the German people, through its Bundestag, is the sole arbiter of any act that have fiscal implications regarding the German people. The Bundestag did not approve the €42bn of ECB programs that have funded the Greek states excessive consumption.

All this is purely theoretical. For the practical implications of the above "falling domino" chain, we go back to Carl Weinberg:

What if a downgrade of ESM paper causes a hedge fund to fail, which triggers the demise of the bank that handles its trades? The costs of fixing failed institutions will also, of course, fall on governments. The ultimate cost of Greece’s default is yet to be seen, but it is surely larger than it seems.

Contained? We think not. And neither does Varoufakis, which is why he is willing to bet the fate of the Greek people on that most critical of assumptions. The only outstanding question is what does Mario Draghi, and thus Goldman Sachs, believe, and even more importantly, whether the Greek people have enough faith in Varoufakis to pull it off...

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JamaicaJim's picture

Short the fucking Euro, and stay short....fuck the pundits, data...all of it.

The Euro is FUCKED


DISCLOSURE: .............i'm short the fucking Euro...and will play the fucker like a pin ball machine Sunday...


Spitzer's picture

On the contrary.


The $eppo is FUCT.  You really think its the end of the Euro because of lack of printing >?


Since 2008, the Fed and BOJ balance sheets has expanded 70%+, the ECB's has expanded 11%.

HowdyDoody's picture

Aaargh, the Domino Theory. This was used to justify war in Vietnam and now appears to be used to justify financial war against Greece.


Tom Servo's picture

Write it down.  A "No" vote is a schism of the status quo.  Therefore "Yes" will win 51/49%.


You heard it here first.


WonderDawg's picture

The vote will be whatever TPTB want it to be. If it's a "no", there's an underlying reason for it.

boogerbently's picture

Greece isn't a big enough "dominoe" to hit the next one.

They are a fart in a hurricane.

crazytechnician's picture

According to fractal mathematics , it would have been a fart that caused the hurricane in the first place.

ATM's picture

In a world of exponential leverage there is no such thing as a fart in a hurricane It is a fact that all farts now become hurricanes.

Carpenter1's picture


"Greece is contained."


But Spain, Italy, Portugal, France, and Germany aren't

KnuckleDragger-X's picture

Yep, its all shiny, so move along, nothing to see here......

boogerbently's picture

IMF/EU QE to infinity coming.



gimme-gimme-gimme's picture

No offence, but this article is bait to trick people like you into going short Euro.


You have to be deluding yourself to think the ECB won't be buying up every new bond issued to cover this crap under their QE program.

NoDecaf's picture

Isn't that the point of shorting the Euro?

two hoots's picture

The EURO/$ or $/EURO will not fail as they are joined at the hip and controlled by the same group.   It may not be pretty but it will not fail.  The EURO was a way to gain control of a batch of uncontrollable currencies and therefore its people throughout Europe.  The plan is too big to fail. 

appocean's picture

who's gonna pay the lawyers.

Arnold's picture

Ambulance kick backs for you!

JustObserving's picture

The actual exposure to Greek debt is miniscule compared to the risk of bursting the global bond market bubble.

Besides, Deutsche Bank has $54 trillion in derivative exposure.  Germany's GDP is only $3.6 trillion.

gimme-gimme-gimme's picture

Not to throw to big a monkey wrench in this stupid thesis..  But did you guys forget about that little thing called QE that ECB is doing?  You actually think any new bonds being issued to cover all this junk will be auctioned off onto the open market?


Man, whoever wrote this artice is pretty damn stupid or trying to trick the gulible into making the dumb decision of shorting the Euro. Sham, shame ZH for publishing something like this!

aminorex's picture

I which case, there are going to be an awful lot of Euros set loose in the face of rapidly disappearing demand.

waterwitch's picture

That's why I have October puts on DB. Time will tell. Tick tock.

EscapeKey's picture

are you suggesting that all greek bonds will be bought by the ECB, who will mark these as assets in their books in perpetuity, even beyond maturity?

that'd be epic fraud many times enron over.

Spitzer's picture

Greece is the Euro's biggest problem and its the smallest state in the bloc

California is the $eppo's biggest problem and its the biggest state in the bloc

OpenThePodBayDoorHAL's picture

Euro-fantasy, that California is equivalent to a Eurozone country. For starters there happens to be a very deep *sovereign* bond market covering California and every other state. Secondly they are politically ruled and managed by the same single entity in Wash, DC. Thirdly they share much more language, culture, history and national myth than Germany and Greece ever matter what Helmut Kohl and Mitterand ever fantasized about. Admit it, the euro is fucked. Eeveryone else is, too, but don't imagine the euro-fantasy can continue much longer.

N57Mike's picture

Chart reminds me of Psalm 46 ..."therefore will not we fear, though the earth be removed, and though the mountains be carried into the sea" ...

disabledvet's picture



Move along...

MaxThrust's picture

I think your Red domino is to far away from Spain's. It's unlikely the impact will knock over the Spanish domino

Knock it sideway probably. It will be up to Podemos to give it a nudge.


i_call_you_my_base's picture

Varoufakis has said it'll cost $1trln. Probably at least.

falak pema's picture

well said ZH; you have placed the Euro zone right where Olivier Sarkozy placed it back in 2010 (or 2011) with his tweet. And at that time the Greek exposure was more like half what it is today.

So taken as a whole Europe has at least twice as much sovereign bond shit lying in ECB vaults and its private banking is not much better off either. 

So..."doing what it takes" makes Eurozone now carbon copy to GS's scamming of Greek books way back in 2001/2002. Well done Mr Draghi you are a repeat performer just like Milady Lagarde maintains the traditions of IMF in being the hit financial team to scam third world nations time and again; now come to good ole Europe.

disabledvet's picture


(All euro's henceforth declared BANNED on order of Prime Minister of Greece...signed "the Finance Minister.")

"No debt will be honored printed in that so called money."

See below because "back in the real world it's still all about political theater."

This so called "game theory" presented here presupposes an outcome where everyone does not lose.

I fail to see that outcome in this instance...

falak pema's picture

except these guys want to stay in the euro. So your scenario is not Syriza's.

They want huge haircuts and 20 year moratorium on repayment. If you multiply that by 4 for all the piggies, (I can't see all those others accepting this only for Greece) you might as well write off the banks... 

So its a nice merry go round.

Bobbyrib's picture

That's a good way to absolutely destroy your relations with your trading partners. They are going to have to bite the bullet, print drachma's and pay back the EU in drachma's.

New_Meat's picture


"This so called "game theory" presented here presupposes an outcome where everyone does not lose."

Actually, in game theory, the usual outcome is that everyone dies.  That was the point of Jonny's original thinking--it takes some clever smarts to avoid such an outcome.

I assess that the pigfuckers involved in this whole mess are not clever, not smart, too arrogant by half to come up with a "solution" that avoids bringing the mosque down around their heads.

I'm a'guessin' that we'll see earlier rather than later.

- Ned

Goldilocks's picture

The Chaser- Yes We Canberra - They're All F*cked (1:52)

OpenThePodBayDoorHAL's picture

Are you from Oz? Let's have a coffee sometime

two hoots's picture

Credit Default Swap:  Insurance, written in an unknown language, paid by taxpayers for bad decisions made by everyone else. 

New_Meat's picture

Bierce didn't have that concept for his dictionary, but the Urban Dictionary needs your update. - Ned

franzpick's picture

Beware of Greeks Bearing Votes...

Tinky's picture

I'd like the collapse to begin in earnest as much as the next ZH reader, but I'm conflicted if it means that Martin Armstrong's "2015.75" prediction were actually to come to pass.

Carpenter1's picture

Armstrong is wrong.


He's like many out there telling us we have time, don't worry.



lordbyroniv's picture

would be so cool if American banks got closed this week too in one giant collapse.

JenkinsLane's picture

FUBAR - It's simply an alphabet soup of fuckwitery, aka "extend and pretend".

I wish Russia was warmer.

Anunnaki's picture

Nnaki-damus predicts

Similar to Scotland

Yes - 54%
No - 46%

I wish no were to win, but Greeks will go with the devil they know: better to be a German slave than risk the unknown future on their own

Gyges's picture

If they're using the published polls it is very likely they are in for huge trouble. The past week the TV channels (illegally) and media have been having a veritable orgasm of propaganda, they dropped their masks completely. Polls haven't been trustworthy for years, let alone in this climate. Of course, they're also conducted by phone call.


Honestly, do you think that the 3million citizens who can't afford POWER and WATER will be happily paying for overpriced communications on Deutsche Telekom and other providers so they can be POLLED?


We have people who sustain themselves from trash bins. They do not have phones to be polled but they ARE CITIZENS and they WILL VOTE come morning.

COSMOS's picture

Time to bring back the Greek City State Model.  This way not everyone gets fucked if there is a slim yes majority.

angel_of_joy's picture

If they vote "Yes", how exactly are they gonna pay their debt obligations ? That's the little question nobody cares to ask...

Wile-E-Coyote's picture

Hold on who is counting the votes? The party in power wants a NO vote, go figure.

As for Scotland it was the other way around, the establishment wanted Scotland to stay. Greece is a totally differant scenario.

This will be a "No" vote win.