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How Dan Loeb Thinks The Greek Crisis Plays Out

As reported yesterday in his Q4 letter to investors, Third Point's Dan Loeb took down his net leverage going into 2015 for one simple reason: a "haunted house market" as he described it, where "a new scary event lurks around each corner", and no event is scarier than a worst-case outcome to the Greek situation.

So how does Loeb see the latest Greek crisis ending? Read on for this thoughts.

Greece Update

In 2014, Greece’s economy started to improve modestly after a long malaise. This progress proved to be too little too late for Greece’s former Prime Minister, Antonio Samaras, whose New Democracy party was defeated in January elections which were triggered by the parliament’s failure to elect a President in December 2014. Samaras was committed to keeping Greece in the EU and had implemented unpopular but necessary fiscal and structural changes to pull the country back from the 2012 brink. Greek voters, who had suffered from austerity just long enough to miss out on its emerging benefits, rejected his approach and elected Syriza, a popular but inexperienced leftist party. Syriza’s first move was to form a coalition with a radical right wing party with whom they shared one key interest: aggressively confronting the Troika. The markets naturally reacted with grave concern.

Today, the situation is changing daily as Syriza finds its footing and faces divisions within its ranks. As we have seen many times before, campaigning and actually governing are two completely separate things and unfortunately, in this case, there is no time to learn on the job. The government is currently dealing with a plunge in asset values and tight liquidity for both the sovereign and banks. Tax collections – a significant, if unpopular, focus of the former PM – slowed significantly in the past few months, putting fiscal pressure on the government. Over the last few weeks, Greek banks have needed to borrow emergency ECB funding at high costs in order to meet deposit outflows. We believe that unless an agreement with creditors is reached this month, Greece will begin experiencing extreme liquidity pressures in early March. These liquidity pressures will only escalate leading into April as government treasury bill obligations and interest payments/maturities to private creditors and the IMF begin to pile up. Greece theoretically has enough liquidity to make it through February and possibly March (absent a bank run) but as we have witnessed time and again, the path to insolvency starts slowly but ends very quickly.

Thus far, Syriza has appeared unwilling to adjust its negotiating strategy to these liquidity constraints, instead choosing to remain firm on campaign pledges not to extend the current Troika program. This will soon create a “between a rock and a hard place” moment since Greek voters did not mandate Syriza to take Greece out of the Euro or default on its debts. The country’s only liquidity source is its EU partners, who will insist on continued monitoring and reforms as a funding condition. Syriza is far from omnipotent – it does not have a majority in parliament and its coalition is viewed as relatively weak given that its partner finished sixth in the elections, with less than 5% of votes, meaning only about 40% of voters voted for this government. A potential outcome of failed negotiations is a collapse of the existing coalition and possibly new elections, which would create significant market volatility but most likely produce a national unity government with a clear mandate to prevent catastrophe.

Despite this chaos, on the other side of the table, no one wants a Greek exit (“Grexit”) from the European Union. We are confident that Germany believes funding Greece and reducing its debt through a politically palatable restructuring is a good investment of German taxpayer funds. In 2014, Germany is poised to break the world record for largest current account surplus (again) at a whopping ~$285 billion, nearly double that of China and triple that of Saudi Arabia. Germany also boasts Europe’s lowest unemployment rate at 4.9%, which is half the Eurozone average and one fifth that of Greece. Both Germany’s current account surplus and low unemployment are enabled only by an artificially low currency which would be threatened with extinction should any Eurozone member opt – or be forced – to leave. As one German politician recently said, “Have you seen what happened to Switzerland?”

These are powerful incentives to drive a constructive German negotiating position, but the German government will not be blackmailed or embarrassed. Greece and Europe should almost certainly find common ground if Syriza can provide real alternatives to Greece’s existing austerity measures while respecting Germany’s need for a politically acceptable outcome. What a Syriza-led government ultimately means to Greece’s economic prospects remains unclear but one thing is certain: if they do not play their cards well in coming weeks, it’s likely we will never know.