Dramatic ending to Greek tragedy
Greece is in the danger zone. Even as the country’s finance minister sought to reassure his euro zone counterparts at a meeting in Poland, Greek credit default swaps were pricing in a more than 90 percent chance of default, according to Reuters calculations of Markit data. Economists in a Reuters poll see a 65 percent chance of that happening, probably within a year.
Such fears recently sent jitters across financial markets, prompting some words of comfort from German Chancellor Angela Merkel and French President Nicolas Sarkozy that they are determined to keep Greece in the euro zone. But speculation is growing that Greece will default, and that it will be a messy ordeal. Here are some of the potential dangers if it occurs:
* Greece may be seen as setting a precedent for Portugal and Ireland, analysts said. Yields on peripheral euro zone debt could surge rapidly, making funding costs increasingly unsustainable as yields on Italian and Spanish 10-year bonds surge back towards 7 percent. The ECB could have to intervene more aggressively in the secondary bond market to the detriment of its balance sheet.
* European banks may have to make more significant write-downs of their Greek holdings than they already have. This would hit French banks especially hard, since they are the most heavily exposed to Greek debt, with $56.9 billion in their portfolio — more than double as much as Germany’s equivalent holdings. French banks are also the most vulnerable to Italian debt, with a hefty $410.2 billion.
* Fears of more contagion and further write-downs could make banks even more reluctant to lend to each other. A key measure of financial stress — the three-month spread between euro Libor and overnight index swap rates — hovered near its highest in over two years. Said Gary Jenkins, head of fixed income research at Evolution Securities:
You would get the loss on the Greek debt of course but I think much more important is the funding situation. Who is going to be lending the banks money if you have got euro zone sovereigns defaulting and you are unsure about what is going to happen next?
* Banking sector problems could hurt equity markets at large: stock valuations could fall significantly, raising concerns over the ability of corporations to raise capital. That would hurt business and consumer sentiment and further diminish the likelihood of a meaningful global recovery, says Richard McGuire of Rabobank.
* The euro could fall sharply versus the dollar towards around $1.20 or below, according to currency strategists, from around $1.38 currently.
Even if Greece gets the next tranche of bailout aid and makes it through October, its future looks bleak.