While concerns persist about the number of houses in the neighborhood that will default, financial markets have focused their primary concerns on whole nations that could abrogate their responsibility to honor their debts. Last year Dubai unnerved investors; today it is Greece.
Other countries have defaulted in fairly recent memory: Argentina, Mexico, and Russia. The implosion of financial markets during the past two years has, however, heightened the angst of investors to any new major credit problem. The Greek government today has debt securities amounting to a total of nearly $400 billion, far exceeding the $155 billion owed bondholders by Lehman Brothers at the time of its collapse.
A default by Greece could trigger concerns that Portugal, Spain, and, possibly, also Ireland could follow. The exposure of European and U.S. banks to security write-downs and losses could be sizable and precipitate another massive drop in asset prices throughout the world.
The potential for another credit meltdown reduces the likelihood that Greece will be allowed to default. While some might recommend that Greece be jettisoned from the Eurozone, the organization takes pride in its unity and can be expected to protect its integrity.
The political choices ahead will be difficult. The finance ministers of the Eurozone have given Greece thirty days (until March 16th) to craft a credible deficit reduction plan. If that plan is not delivered, specific measures, such as a tax on luxury goods, will be recommended. Look for Greek citizens, especially those affiliated with labor unions, to stage major protests. But, fiscal austerity will be required. The opposition of German taxpayers to any “bailout” of Greece is intense.
Eurozone leaders hope that Greece will develop a fiscal plan that will convince investors that it is serious about restoring financial prudence. While a tightening of fiscal policy could slow economic growth, the recent softening of the Euro is helping Greek and other European goods be more competitive in export markets. Failure to develop a believable budget plan could jeopardize growth even more by raising interest rates through higher risk premiums.
The next thirty days will be critical. Stay tuned.