Greece just fired the EU’s bazooka. Attempts to talk down the crisis in Greece failed spectacularly with Greek Bonds approaching that of Taliban ridden Pakistan.

Please consider Greece Calls for Activation of Financial Rescue

Describing his country’s economy as “a sinking ship,” the Greek prime minister formally requested on Friday an international bailout, testing the solidarity of the European Union as never before.

“We drew up a plan, we took difficult and painful measures,” Prime Minister George A. Papandreou said in a nationally televised address. “But the markets did not respond. The time has come for us to ask our partners in the E.U. to activate the mechanism we formulated together.”

He was referring to an emergency aid package arranged two weeks ago in Brussels. The plan foresees up to €30 billion, or $40 billion, in loans from Greece’s euro-zone partners, and up to €15 billion from the International Monetary Fund.

The activation of the E.U.-I.M.F. rescue plan, Mr. Papandreou said, “will send a strong message to the markets that the E.U. is not playing their game and will not leave its currency at risk.”

“At some stage the euro area will arrive at a fork in the road,” said Gerard Lyons, chief economist at Standard Chartered Bank in London, “as some economies are structurally different to others.”

For Greece, Spain, Italy, Ireland and Portugal [The PIIGS] the financial crisis has highlighted the constraints of euro membership. Unable to devalue their currencies to regain competitiveness, and forced by E.U. fiscal agreements to control spending, they are facing austerity measures just when their economies need extra spending.

Mr. Lyons said the long-term choices for the euro area appeared stark: Either push on toward a political union, handing budgetary power to a central authority, or form a “two-speed” block.

Strong Message To EU

Greek Prime Minister says activation of the E.U.-I.M.F. rescue plan “will send a strong message to the markets that the E.U. is not playing their game and will not leave its currency at risk.”

I say the market is sending a strong message to Greece and the EU that this is the tip of the iceberg when it comes to EU sponsored bailouts.

Debt to GDP Map

13 of 27 EU nations, including France and Germany exceed debt limits set by the European Commission.

See Debt Rising in Europe for a nice set of interactive maps.

What Countries Hold Most Greek Debt?

Inquiring minds are reading Still in a Spin for clues as to what countries hold the most Greek debt.

Our debts, your problem

Yet the alternative to a bail-out—default—is too grisly to contemplate, not least because of the dire consequences for Europe’s banking system. Banks in Greece hold €38.4 billion-worth of the government’s bonds, according to Deutsche Bank. This amounts to almost 8% of their total assets. A big write-down in the value of those bonds would leave the banks crippled. But around 70% of Greek government bonds, €213 billion-worth, are held abroad, mainly elsewhere in Europe.

There are no solid figures on how much of this is held by banks but it is possible to make rough guesses. The Bank for International Settlements (BIS) provides figures for foreign banks’ lending to the Greek government, Greek banks and the private sector combined. Furthermore, according to analysts at the Royal Bank of Scotland, banks bought a bit less than half of the Greek bonds sold between 2005 and 2009. Based on these figures, table 2 contains our estimates of which countries’ banks own Greek public debt.

The “low” figure is calculated using the weight of each country’s total exposure to Greece in the BIS figures. For instance, French banks account for a quarter of all foreign-bank loans to Greece. If we assume that half (ie, €106 billion) of the €213 billion of Greek government bonds owned outside Greece are held by banks, and that French banks have a quarter of that, their share is €27 billion. On the low estimate, euro-zone banks own €62 billion of Greek government bonds.

The true exposure is probably a bit higher, perhaps €70 billion. It is more likely that holdings within the euro area are weighted more towards commercial banks than pension and insurance funds, because banks are able to use Greek government bonds as collateral for cash loans from the European Central Bank (ECB). The “high” estimate assumes public debt accounts for all the foreign banks’ lending to Greek entities in BIS data. This is surely an overstatement, but the exposure of German banks, for instance, is likely to be much closer to our high estimate, €30 billion, than the low one.

Given the pain that a Greek default would inflict on the euro area’s banks, it is perhaps not surprising that the currency club’s governments have rushed to announce firmer details of a bail-out.

One look at the above chart is all you need to see to understand why France has been the most vocal supporter of bailing out Greece. For comparison purposes, US and U.K. banks avoided this mess.

For interest rate and CDS charts of the Greek bond crisis, please see Greece Budget Gap Worse Than Feared; Bonds Approach Pakistan Levels; Greek Bond Crash In Pictures.

Mike “Mish” Shedlock
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