A Domino Game That Could Spread Very Far

 

We all have at one time or another, spent time trying to set up the perfect domino effect, where the fall of one piece leads to the fall of every other piece in the game. These days, most negative views are based on the theory that the same could happen and might even be on the verge of doing so. While a domino game usually needs some kind of manual intervention, this one would likely start when Greece will confirm that it is indeed defaulting on its debt. The exact way it will be done, the conditions and direct consequences are unclear but the fact that Greece will have to go down that road look certain by now.

Surviving The Domino Effect

The challenge for countries, corporations and investors is to get a clear vision of what will be knocked down by the domino effect, and what will not be. For example, it seems clear that European banks will suffer greatly from a Greek default. Why? Because they have been able to avoid mark-to-market on their positions meaning that their books still reflect a AAA-Greece. Needless to say that taking a 50% cut will result in massive losses. Most agree that the worst off are the French banks as they have massive exposure to these banks.

The question then becomes, if French banks do suffer such losses, will one or several them be unable to operate? Christine Lagarde, the former French finance minister and now head of the International Monetary Fund (IMF) has been urging the banks to increase their capitlizations, which some have done and others not. If one or several of them would fail, what kind of impact would that have on credit markets? If US bank Morgan Stanley (MS) is said to have a huge exposure to French banks, would that mean that Morgan and other US banks could also be threatened? If so, where does this end?

There Are Several Possible Paths

If that was the only path, it would be a lot easier to fix. But consider the fact that a Greek default could bring increased pressure on other EU countries like Ireland and Portugal but also giants like Spain and Italy. There is absolutely no doubt that this is the more serious path and brings by itself a large number of other scenarios.

What To Do As An Investor?

Clearly, pressure is on for investors like you and I. How is it possible to anticipate everything that could/will happen when Greece does actually start to falter. This is also something that will likely happen over a few months/years so I would personally consider it neatly impossible to try to time all of these events. There will be great opportunities for those willing to take some risks but if you do consider yourself someone that cannot afford or support a 20-30% loss, I would recommend being very safe until the Europe crisis resolves. Of course, by doing so, you could end up missing a big rally that will occur if they do come up with a solution. There is always a downside to avoiding risk.

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