Potential Outcomes of a Greek Default
What are the Chances?
The chances of a Greek default are today undoubtedly higher they were a year ago. The Greek government does not seem to take budget cuts all that seriously, in fact the Country’s budget deficit has increased during 2011 when compared to 2010.
This is only partly due to disappointing revenue streams. True, the Greek economy is still floundering, but the government is not really managing to keep expenses under control either. Technically, spending during 2011 was 1.2 percent down compared to 2010, but if one includes certain special items it is actually higher than in 2010. The Government’s position is further exacerbated by the fact that it does not have the support of the Greek public for these austerity measures.
All of this has led to an increased likelihood that sooner or later the country will not be able to service its debt, which will have serious implications for both Greece itself and the outside world. So what are some of the possible outcomes?
Greece’s banks are heavily exposed to the country’s sovereign debt. A default will give many of them a severe haircut and leave them in a situation whereby they need to be recapitalised in order to make up for the massive losses. This could even result in a run on Greek banks by depositors.
In such a scenario, the government might well have no choice but to declare a ‘bank holiday’ to prevent this from happening. Eventually, the government might have no choice but to nationalise the banks that are most heavily exposed.
Europe’s banks are heavily invested in both Greek government bonds and private debt. The amount involved is in the region of $53 billion. The most heavily exposed countries are Germany, France and the UK.
Many analysts talk about a 40% ‘haircut’ in the event of a Greek default. This could mean losses of around €15.6 billion, which might well be all that is needed to push Europe formally into a recession. Some analysts even predict it could bankrupt the European Central Bank.
The possibility that the Greek government might decide to abandon the Euro is still lingering in the air, although countries such as Germany would not like to see this happening.
Credit Default Swaps (CDs)
The exact extent of the exposure of various financial institutions to Greek credit default swaps is virtually impossible to calculate, but financial institutions have been selling protection valued in billions of Euros on Greek debt over the past couple of years. A figure of $3.7 billion is widely quoted in this regard.
If Greece defaults, these institutions will have to cough up the money, which will have a further ripple effect on financial markets in Europe and even the US.
Banks will be even more afraid to lend money to each other under these circumstances, which will make economic recovery even harder to achieve.
Non-Payment Ripple Effect
If Greece should default, it might well create a precedent for countries such as Portugal and Iceland, who are also heavily indebted. After all, why should they pay in full if Greece can get away with giving their creditors a haircut?