He got it right. Des Lachman put a stake down and predicted that Greece would default in May 2010. Today, it did.
Though some had talked about it, few were willing to stake their reputation on the probability of a Greek default. Lachman said, in testimony to a Joint Economic Committee of the Congress, “There is every prospect that within the next twelve to eighteen months Greece will default on its US$420 billion in sovereign debt.” Fifteen months later, the ECB arrived at a debt accord that would give holders of sovereign Greek debt a 50% haircut – more or less, a technical default.
Lachman argued that a Greek default would precipitate the rapid dissolution of the European Union. Weaker or peripheral economies would soon follow suit. Some might choose to leave the Union, reclaim control of their monetary policy, and aggressively devalue their currency to encourage exports and grow their way out of onerous and unfunded domestic obligations without the penurious effects of EU-mandated austerity programs.
The Greek “default” is, just as Lachman argued, probably the largest sovereign default in history. It differs in one key way, though. The EU coupled it with a $1.4t commitment by the European Financial Stability Facility to stem the possibility of the cascading defaults and crisis described by Lachman. It’s their stab at the shock and awe the US Treasury generated when it asked Congress for $700b to fund TARP in an effort to demonstrate and unflagging commitment to backstop the banks. Just as Roubini argued in 2009, the longer it was put off, the larger it would have to be, and he, too, was right.
The EFSF backstop may provide just that, but it’s still too early to tell. The EFSF is highly levered. CDS’s will have to settle or meet some turgid explanation to the contrary. Banks will have to reassert the the viability of their capital structures. Greece will have to respond when the market asks, now what? as it begins to consider their novel fiscal condition. And all of this will transpire under the watchful gaze and mercurial influence of the investment community and the mythical bond vigilantes.
But Europe did not complete the process on its own. Sarkozy finished yesterday with a promise to call Hu Jintao, the President of the People’s Republic of China. His offer was simple. Balanced the prospect of disarray in Europe and a commensurate decline in Chinese exports with a commitment to fund the EFSF. President Hu welcomed the opportunity. But it’s worth wondering what Premier Wen meant when last month he said, China is willing to help, developed nations must “put their houses in order.” And now that China has helped, what it might expect.
The story is far from over, and the Greeks are far from happy. Says Dimitris Papadimoulis, “Those who monitor us do not have our interests in mind. Their priority is that we pay back our loans.”