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Why a Greek Default Could be Worse Than the Lehman Collapse

The 2008 collapse of Lehman Bros Holdings Inc. (PINK: LEHMQ) ignited a financial meltdown that resulted in widespread bank failures and caused the Dow Jones Industrial Average to lose 18% of its value in just one week.

Yet a Greek default – which (even with a bailout) becomes increasingly likely with each passing day – would actually be much, much worse in many respects.

Sure, it's possible that European Union (EU) taxpayers will soon be dragooned into yet another rescue plan. But that would only delay the inevitable – a catastrophic collapse that will drudge up feelings of panic we haven't witnessed since the global financial crisis hit its apex nearly three years ago.

Here's why.

Dodgy Debt and a Dozing Economy

Greece's debt, at about $430 billion, is less than that of Lehman Brothers, which owed around $600 billion at the time of its bankruptcy. But Greece's finances are much less sound.

Whereas Lehman Brothers participated in the 2003-07 financial bubble with considerable enthusiasm, accumulating vast amounts of the dodgy subprime mortgage paper whose value collapsed in the 2007-08 downturn, Greece's misdeeds date back much further – to its 1981 entry into the EU.

As the poorest member of that group, Greece became eligible for a vast array of inventive subsidies, primarily related to agriculture. However, the frauds the country perpetrated to justify even larger subsidies were even more inventive. And this allowed Greece to bring its living standards close to the EU average, while still being subsidized as if it was a genuinely poor country.

Indeed, Greece produced nothing close to the level of economic output that would be needed to justify its spending and the lifestyle of its people.

The problem for Greece is thus stark: Its people need to suffer a decline in living standards of about 30% to 40%, so that the country's output is sufficient to repay its debts.

A Greek Default Will be a Tough Sell

From 45th place in the world ranking of per-capita gross domestic product (GDP) – above Spain, Israel and New Zealand – it needs to lower its living standards to about 65th place. That would put it on a level with Poland, below Hungary and Slovakia, and only modestly above the very well run Chile.

Needless to say, the Greek people are not about to vote democratically in favor of this outcome.

In a truly free-market system, without massive subsidies and with independent currencies, this could be achieved by a collapse in the value of the drachma. Even with the EU and the advent of the European euro currency, such a collapse would probably have happened 10 years ago if the Greek government had not undertaken fraudulent accounting to make its economy appear qualified for euro membership.

That's the advantage of a true free market system; the Greek populace can demonstrate all it likes, but if the value of the drachma drops 40%, there's nothing the Greek citizens can do about it – it would be like staging sit-ins against the Law of Gravity.

Worse Than Lehman

In the system we have, the bailout staged last year by the EU and International Monetary Fund (IMF) was too lenient. It gave Greece too much money and left far too many opportunities for the Greeks to trash downtown Athens in protest.

Since the IMF and the EU insist on being repaid before private creditors, the banks that lent to Greece have been bumped well down the creditors' totem pole. The upshot: Those banks are on the hook for more than $100 billion.

This is exactly why a Greek default would dwarf the Lehman collapse: There were no artificial forces damaging the banks' position in the Lehman bankruptcy, and Greece has fewer viable assets than did Lehman. That means the losses to the banks – almost all of them European banks, in this case – will probably be greater in the event of a Greek default than they were in the Lehman bankruptcy.

As was the case for Lehman, a Greek default would require another bank bailout, another period of cockeyed fiscal and monetary policies, and another major recession.

The only difference this time around is that the global recession and bailout will be centered on the EU – as opposed to the United States.

And that's at least a small bit of comfort to us American taxpayers.

Action to Take: For investors, there is no easy way to make money from a Greek default. Buying dollars in the hope the euro will collapse is a short-term strategy, at best, because the U.S. government has its own budget, balance-of-payment, and monetary-policy problems.

However, if a Greek collapse leads to another bout of money printing, there can be no question that inflation will spike.

That said, there are two things you can do to protect yourself against the coming Greek default.

First, you can invest in gold through the SPDR Gold Trust (NYSE: GLD). This fund will fall in price as Greece's default leads to a global panic, but it will quickly recover as yet more money is printed.

Secondly, you can buy CBOE long-term put options on the Standard & Poor's 500 Index. On example would be the December 2013 700 contract (CBOE: SPX1321X700-E). This contract will soar in price when Greece defaults, more than offsetting any losses on GLD.

In the longer term, money printing and renewed inflation may make the market rise and these options fall back, but by that time GLD will be rising and you can safely sell the puts.

Finally, we should get angry at the monetary policies that have led to a series of bubbles, each succeeded by a damaging panic and crash. There's no way to argue the point: U.S. Federal Reserve Chairman Ben S. Bernanke and his predecessor Alan Greenspan have a lot to answer for.

[Editor's Note: As a global merchant banker Martin Hutchinson guided clients, companies and even entire countries by capitalizing on near-term opportunities, and by riding long-term trends.

Because of its impact on commodity prices, both in the near term and over the long haul, the rising global population requires Hutchinson to search for those more-immediate profit openings, while also scouring the horizon for the long-term trends that can create the hefty profits investors seek.

Indeed, in his "Permanent Wealth Investor" advisory service, Hutchinson has identified one particular global economy that meets all his requirements, and represents such a rich profit play, that we couldn't give it – or the investments he's recommending – away for free.

To find out more about these investments, and Hutchinson's service, check out this link.]

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  1. Kevin Beck | June 1, 2011

    I would only wish that Greenspan and Bernanke testify under oath and answer honestly. I doubt that they would do anything except invoke their Fed privilege to not be held accountable for the disaster they perpetrated upon the world. They deserve the most severe punishment available.

  2. Werner | June 1, 2011

    Very good analysis.
    European banks are going to be in big trouble indeed.
    But let's extrapolate, the Greek meltdown will be dwarfed even more by the US meltdown, and in that case all banks, worldwide, and governments will be left with worthless paper issued by the USA.
    So where to go with one's money as long as it still appears being worth something?

  3. W W Andrews | June 1, 2011

    The best investment will be Swiss francs.

  4. Allen Novotny | June 1, 2011

    Where to go?? BUY GOLD.

  5. dionysios dallas | June 1, 2011

    In case you pretend you don't know, it was through its US based GOLDMAN SACHS recommendations and consultations (for which I must mention earned them a rather hefty fee) to the Greek government to undertake fraudulent accounting to make its economy appear qualified for euro membership. In order to qualify, this was also done by other Europeans. Isn't it interesting!
    Greece is the only European country who never put in claims for damages (Euro 70 bil) by the Germans during World War Two.
    Greece was also one of the nations that lent money to the poor Germans after the devastation of the war.
    I got more, but you wouldn't be interested.

  6. Paul Dueweke | June 1, 2011

    Airports and schools will be named after Bernanke and Greenspan. That's how America punishes the likes of Wilson, FDR, Reagan, and Bush.

  7. Tommy | June 1, 2011

    What effect would this have on the DOW and commodities, if Greece defaults? Are we going to see similar outcomes that happened in the US once again?

  8. Warren Brown | June 1, 2011

    One of the places to go with your money is Australia.

  9. John Mcgillivray | June 1, 2011

    We have just seen a very nervous day on the NYSE, the Eurozone is in crisis, even Australia is now talking of the "R" word.

  10. Petri Lahteenmaki | June 4, 2011

    Go Gold. But not physical but miners.
    Search for producers that just started, they will have a very smooth journey for years to come.
    As for modern history of Greece. Does not matter what was, just what is.
    I live in Sweden and we probably have the highest tax pressure in the world. My salary after all taxes been paid is 26% out of the sum of all invoices.
    In this country we do have same issues like Greece only the control is more rigorous.
    Does not matter how low, high the taxes are unless they are collected to the full.
    Why have (taxation)laws if they don´t apply to everyone?

  11. Jarrod | June 5, 2011

    You may wish to think again before sending your money to Australia. I live here and I can tell you that our stock market has under performed almost all other developed economy markets (and is rolling over now), our house prices are starting to roll over, inflation is above what our Reserve bank likes (and we expect another rate rise anytime), the high dollar is hurting manufacturing, and our biggest trade partner China has a housing bubble that will dwarf the US. It's stock market has just last week broken through an uptrend line that has been in place from march 2009. And if you are familiar with yield curves our 2 and 10 year notes are 60 points away from inverting not to mention that we just has a largest fall in GDP in 35 years. I am going into cash and ride this one out. Opportunities will be on offer for those with cash in time.

  12. hoy | June 7, 2011

    *Dredge up* I believe you may have meant, as in mud from a river bottom,otherwise good stuff.

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