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Greek Euro Exit? More Pain Than Gain

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

NEW YORK (TheStreet) -- In a recent blog post, we argued that, despite her credentials, Christine Lagarde may not be the best choice for heading the International Monetary Fund (IMF). This is because of her bias to protect the French, German and European banks from the losses they will have to take in a Greek default. We also think she will pursue the same "extend and pretend" policies that were put in place a year ago rather than face up to the fact that we are dealing with insolvency, not temporary illiquidity.

The Moral Hazard Expectation

It is clear that Greece will never be able to repay its debt in today's euros, and European banks are clearly in jeopardy. Yet the market has yawned, and European bank equity values have been untouched. A comment received from a colleague regarding that blog post read, in part:
If she [Lagarde] gets into position and kicks the ball down the road a ways, it will only be to give these big banks a chance to off-load and write-off Greek credit over a few years which will make it more palatable when the time comes to restructure.

The market appears to have much the same attitude expecting the governmental institutions to save the "systemically" important financial institutions. Moral hazard is now the expectation. Not only are all depositors implicitly protected, but so are the shareholders, bondholders and the managements. We always thought that investing was a risk-reward business. Investments that fail are supposed to penalize the investor through a monetary loss. There isn't supposed to be a floor of book or par value supported by public funds.

The Implications of Additional Austerity

We suspect the reason for the kid gloves treatment is that the alternatives inflict too much short-term pain. As mentioned above, a Greek default significantly impacts most large European banks. Rather than recognize the impairment of the investments in Greek debt, in exchange for additional monetary support, the European Central Bank (ECB) and IMF will likely impose even more stringent austerity measures on Greece than the ones that currently exist and cannot be met. What isn't factored in is the impact this will continue to have on the Greek economy and its population.

It was only 10 years ago (2001) that the government of Argentina was compelled by the IMF and other large institutional debt holders to apply more and more austere measures on its economy in order to pay back debt. In December 2001, the austerity imposed was met by protests that quickly erupted into revolution, governmental overthrow, and eventually a tacit default. Is this where we are heading again?

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