Is Greece Europe's Lehman?

The Greek financial crisis has reached atipping point. The Hellenic Republic's travails have been analysed ad nauseamfor two years now. Standard & Poor's rates Greece the riskiest sovereign credit in the world and Greek 10-year government bonds pay a yield of 17% - some 14% higher than in the US or Germany.

The Papandreou government has won vote of confidence on June 21, but austerity vote will be the difficult part. For ancient Greeks, centre of the world was Delphi, where an oracle foretold the future. For modern Greeks, focus is Syntagma, the square in central Athens where thousands mass daily to protest government austerity measures totalling 21% of Greece's GDP (in US GDP terms, this would be equivalent to $3 trillion of cuts and writeoffs). The IMF is blocking a critical 12-billion euro aid to Greece just weeks before it is due, since its policy prevents it from disbursing aid to a country that cannot pay its bills for next 12 months.

Eurozone finance ministers apprehend that under the current 110 billion euro bailout, Greece will run short again in March 2012. One option for Greece to pay for its debt is to print money and devalue its currency. But it cannot do so under EU covenants - talk is intensifying of Greece returning to the drachma.

If Greece successfully raises 30 billion euro from privatisation, its government debt would still equal about 150% of its GDP in 2014. Bulk of outstanding Greek debt would be in public hands - the troika of European governments, the European Central Bank and the IMF - and would presumably have seniority.

Remaining private sector holders would be squeezed into accepting greater haircut -an alarming prospect for the European financial system. Big banks, especially in Europe, have massive exposure to Greek debt. And just as Lehman's bankruptcy in September 2008 led to meltdowns at other big financial firms, the worry is that if Greece defaults, it could be the first proverbial sovereign domino to fall. Europe's other oinkers - Portugal, Italy , Ireland and Spain - may play the role of Merrill Lynch, AIG, Washington Mutual and Wachovia.

After Lehman, there was initial shock - but the collapse of stock, commodity and currency markets did not happen for a few weeks. What are the parallels this time? Markets think some form of Greek default is inevitable. If Greece cuts government spending, it will only succeed in reducing its tax revenues and making its debt harder to pay. The possibility of Greek default is rippling, Lehman-like, into unlikely places. When investors are nervous, they tend to seek refuge in the Swiss franc.

It was a good idea to take out mortgages denominated in Swiss francs when franc was stable, but once franc pushes upwards, it could result in double-dip housing recession in Europe. Today, franc is so overvalued that Swiss government last week downgraded its economic forecast, blaming its uncompetitive currency.
source-economic times
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