Even though Greece has been in the news multiple times over the past 5 years, I thought it was worthwhile to provide some facts and thoughts about the current situation. This time appears to be different as we have a politically inexperienced Greek government that has decided to avoid making the tough decisions and instead turned it over to the Greek citizens to  tell the government what to do. This raise the odds that the ending to the current crisis may be different than the previous times.

1) Greece Prime Minister Tsipras surprised European leaders by breaking off negotations related to their debt situation and convincing the Greek parliament to hold a referendum on July 5th to let the citizens decide whether to accept the European Union’s terms for additional financial aid or whether to reject it.

2) The European Central Bank responded by freezing the emergency funding that they have been providing the Greek banks at current levels. This cut off any additional borrowing from the European Central Bank since the Greek banks are at their maximum borrowing amount at this time.

3) Since Greece did not reach a financial agreement with the European Union to renew or extend their borrowing arrangement, Greece will most likely technically default on their payment to the International Monetary Fund on June 30th.

4) The European Commission announced a bank holiday for Greek banks until July 6th and instituted capital controls. This means that the Greek banks are closed until July 6th and withdrawals from Greek banks will be limited to 60 Euro per day.

Thoughts:

1) Greece has decided to move this issue from the financial arena to the political arena by breaking off negotations and holding a vote of their citizens.

2) This should not really be surprising since Prime Minister Tsipras and his political party were elected on the platform that they would not borrow more money from Europe, they would achieve financial concessions to renegotiate their debt and reduce austerity programs. If they had agreed to the European Union’s terms, they would have reneged on what they promised in their election platform. So, now they are asking the Greek citizens to tell them what to do.

3) Europe appears to believe that a Greek default and/or exit from the Eurozone is manageable and will not create a “contagion” problem throughout Europe. This is an unknown situation since it has never happened before.

4) From an economic perspective, Greece should have little impact to the global economy. Their economy is in severe recession already, so there should be little new economic impact. The U.S. economy is showing signs of picking up strength now that the winter weather and West Coast port problems are behind us and Quantitative Easing in Europe is showing signs of helping the European economy. This should offset any weakness created by Greece.

5) The risk is more from a financial markets perspective. Again, on its own, a Greece default and/or exit from the Eurozone should have minimal impact since the European Central Bank and the International Monetary Fund are the primary owners of Greek debt. This is different than when the Greek financial crisis first started. At that time, European financial institutions were the primary owners of Greek debt. Where the risk exists is if unintended or unanticipated consequences develop that the World Central Banks cannot contain or control. The Federal Reserve thought that letting Lehman Brothers collapse would be manageable but then found out that it was not. Whether this happens with Greece remains to be seen. The difference with Greece is that the problem has been known for over 5 years and a default would not be a surprise like Lehman Brothers.

6) The initial reaction from the world equity markets has been a sharp decline. This does not appear to be the start of a Lehman Brothers situation at this time. Instead, it appears that equity investors are temporarily moving to save haven investments (i.e. German and U.S. Treasuries) until they see how the vote goes next weekend and how the situation plays out.

So Why Has Europe Taken Such a Hard Stance?

Europe has taken a hard line with Greece for two primary reasons:

• They do not feel that Greece has made the tough structural changes that are needed to achieve financial stability. Essentially, they believe that Greece has acted more like a spoiled child and Europe does not want to reward “bad” behavior. They cite the example of Ireland and Spain, who both instituted tough reforms that plunged their economies into depression but are now showing evidence of emerging from their economic downturns with a stronger financial position. Europe believes that Greece needs to do the same.
•  Europe does not want to set a precedence. Their fear is that if they renegotiate Greece’s debt without having Greece institute the structural reforms that is needed for long-term financial viability, then other countries will try to use the same strategy. Europe is essentially sending a message to the other anti-Euro political parties throughout Europe that this type of strategy will not work.

For now, until the referendum occurs, expect lots of noise and volatility.