The Greek Shuffle

Greece!

Or maybe by now, that should read, “(Sigh.) Greece.” It might seem old hat, but Greece again took headlines for much of last week. The week began with politicians telegraphing transatlantic messages affirming confident support of Athens—with US Treasury Secretary Tim Geithnerand several eurozone leaders chiming in. As the week wore on, five central banks announcedcoordinated action targeted at aiding European banks’ access to US dollar funding—an incremental step forward. And Friday, in a move largely designed to curry domestic political favor for the likes of Germany’s Angela Merkel, eurozone leaders delayed voting on Greece’s next bailout disbursement until October, calling for imposition of new Greek austerity measures in the meantime.

So the pattern: A verbal show of confidence; an incremental step forward; then, a politically motivated, incremental step back. Very similar to the pattern followed in July (and several times before).

All the while, many in the media have argueda dramatic resolution for the worse looms. But after two years of headlines expecting it, no major, shocking endgame has occurred. Politicians have continued dancing their Greek two-step—two forward, one-and-three quarters back. Given the near-constant media glare on Athens since their dodgy debt data first came to light in late 2009, it’s a bit understandable folks are quite weary of the story already. But at the same time, taking a slow, measured and highly publicized approach isn’t a bad thing for markets.

Sure—the slow path ensures a whole lot of political gamesmanship. But it also means the details of plans, deals and possible hang-ups are in full view—mitigating potential shocks along the way and providing analysts and banks time to assess the potential fallout (if any) of plans. Banks commonly hedge against losses by setting aside reserves, adjusting leverage, boosting liquidity and more. Time granted to them by eurozone leaders’ dithering is a plus in this process. And maybe it’s not solely due to Greece, but eurozone banks have strengthenedcapital markedly in the last few years. That’s not to say there’s no possibility of any problem—but the absence of a sudden, fast-moving Greek conclusion helps banks diminish potential issues.

This tortoise’s pace has other benefits as well. For example, many feel a Greek default is the likely ultimate outcome. In fact, the second Greek bailout agreed to in principle by eurozone leaders July 21 includes what’s widely considered a selective default: Voluntary private-sector participation amounting to an average 21% principal reduction. But let’s say that haircut isn’t enough to make Greece’s debt load sustainable—which seems likely to us, absent a major turnaround in Greece’s economy. Greece could gradually restructure, over time reaching what we feel is a more reasonable 35%-50% principal reduction. A step-by-step method means banks have time to gradually use profits—most eurozone banks are profitable—and other means to boost reserves. It also allows eurozone leaders to construct firewalls (like the EFSF enhancementcurrently awaiting national parliamentary votes and credit lines for banks). In this gradual default scenario, the surprise factor is largely absent. It doesn’t necessitate a sudden, disorderly end to the euro. And an organized default by an economically small eurozone nation isn’t a likely catalyst for a global bear market or recession. As for the “contagion” of default fears some believewould follow even an orderly Greek default, that’s precisely why firewalls are being discussed.

Last but not least, it affords Greece time to reform its economy. (Translation: Shun socialist tendencies.)

Ultimately, it seems to us most in the media await a dramatic conclusion to the Greek story—one way or another. And most play up the possible and downplay what’s more likely. It might be tiresome to see Greek headlines, day after day, month after month. But in our view, that’s the likely road forward, and one that’s not entirely bad.