SVM’s McLean proposes euroland split

Colin McLean, managing director of SVM Asset Management, has proposed a North-South split in the eurozone to enable Greece to remain in the currency block without threatening other members.

The cost of trying to maintain the Eurozone might prove too much for the voters of Northern Europe. What is needed is not an exit by Greece from the Euro, but a split in the Euro roughly across a North / South divide. This would see Germany cease to have an undervalued currency, and the Mediterranean countries would get a boost from devaluation. This would address the underlying problem, and stockmarkets might respond surprisingly well to this. What investors need is clarity, not another European fudge.

Greece’s problems go well beyond debt. The budget deficit will not be corrected until the economy is comprehensively reformed. Greece is one of Europe’s most regulated and least entrepreneurial economies. It has a generous welfare system, a rigid labour market and a low tax base. The underlying reason for the debt must be addressed. Without that there will be few takers for any of the assets that Greece needs to sell to balance its books.

Until recently, Greece seemed unimportant to the European economy – just 2% of the EU total. So why has the prospect of a Greek debt default hit stockmarkets so hard? As the turmoil has unfolded many billions have been wiped off share prices. How concerned should investors be?

The [UK] Treasury urged British banks to accept huge losses to help Greece. Given the taxpayer money that funds two major UK banks, and the fact that the UK is already struggling with its own austerity programme, this reveals the level of official panic. Even though Britain might not be contributing directly to the latest EU rescue for Greece, there are big hidden costs. Britain has the third largest exposure to Greek debt – our banks own Greek bonds worth about £3 billion – but the risk to the British economy far exceeds this. Not least is the likelihood of Spain and Italy facing financing problems if a solution is not found for Greece. Ireland could chose to default on its bank creditors, which might avoid a sovereign default.

As emerged after the Lehman Bank failure in 2008, complex financial derivatives can mean that losses emerge in unexpected areas. Is the knock-on effect of Greek problems factored into our own austerity plan? European banks are stronger than they were in 2008, but they are ill-prepared for more losses. Under a French plan for Greece, banks across Europe are being pressured to roll-over their Greek bonds, turning them into much longer term debt. Losses on this for banks might be spread over three years, but it still looks like a short term fix. And the rate of interest that Greece would pay would not be commercial, meaning that lenders are not being properly compensated for risk.

Banks share prices reflect the fears. Banks remain exposed to problem loans, particularly to the UK mortgage market and commercial property. Investors need to assess carefully any investments in banks and insurers.

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