The Greek economic crisis continues to make headlines as Prime Minister George Papandreou attempts to maneuver the governments contentious “austerity” bill through the Greek parliament. As predicted, protests against the government’s plan to deliver nearly 30 billion euros in spending cuts and tax hikes have grown in intensity and the fear is that the debt crisis will not be contained within Greece’s borders. Portugal’s credit rating has been reduced to “junk” status and Europe’s banking system is dangerously exposed to massive amounts of questionable debt. The very future of the Eurozone hangs in the balance.
More on Greek Debt
A Default by Any Other Name
In late June, European Union officials announced they were close to arriving at a solution that would see in excess of 100 billion euros made available to Greece. The plan includes a provision to “roll-over” a percentage of the debt owed to investors. Innocuously described as a “re-profiling” of Greece’s debt, the intent is to give Greece a little more breathing room by delaying the payout on maturing securities for those investors willing to wait for full payment.
This scheme was well received and even actively promoted by the major financial institutions in France. This enthusiasm is understandable when you consider that public and private banks in France alone have nearly 57 billion euros invested in Greek bonds and other government debt. German financial institutions are also heavily invested with 34 billion euros at stake and they too – albeit somewhat grudgingly – agreed to roll-over a portion of the maturing debt. Being forced to wait for full payment is obviously preferable to taking a loss.
While the European banking system may have given the plan a thumb’s up, the ratings agencies were not so inclined. Standard & Poor’s issued a statement confirming that, in their opinion, a deferment was just another type of default event. Accordingly, the ratings agency would be obliged to downgrade Greece’s debt rating to reflect the default.
This introduces a series of complications, not the least of which is the fact that this designation would make Greece’s debt ineligible as collateral for the European Central Bank. This alone would derail the proposed debt-relief plan as Greek bonds are expected to backstop loans from the Central bank. A “default” status would make it impossible for the bank to accept the bonds as collateral.
While French and German banks are two of the more prominent foreign holders of Greek debt, other European financial institutions also have significant exposures. The fear is that should Greece default on its payments, it could trigger the collapse of these institutions thereby spreading contagion throughout the European banking system.
This concern was highlighted by a pronounced sell-off in debt issued by the PIIGS (Portugal, Ireland, Italy, and Spain) following the June 5th action by Moody’s Investors Services slashing Portugal’s credit rating to “junk”. All eyes may be on Greece right now but there is a strong likelihood that history will repeat itself as other debt-strapped nations come face to face with their own economic crisis.
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