Other than those planning vacation cruises, very few people in the United States spend much time thinking about Greece. Suddenly, however, Greece is all over the news. Financial television spends considerable time evaluating the political fortunes of Prime Minister Georgios A. Papandreou. Network news covers protests and violence on Greek streets. Tiny Greece is assuming a level of importance not seen for centuries. What happens in Greece this summer may determine the health of the world economy and securities markets.
Having lived well beyond its means for many years, Greece now finds itself unable to repay its debts coming due. It has already received a massive infusion of rescue money from its European neighbors in exchange for a promise to mend its profligate ways and run a tight financial ship. Grateful for that earlier rescue, but not enough to mend its ways, Greece finds itself begging for another giant handout to meet bills coming due in mid-July.
In the grand scheme, it would seem that a default by tiny Greece would be inconsequential. Why are its much bigger neighbor countries jumping through hoops to prevent a default on Greek debt? It's complicated.
For one thing, Greece was accepted into the European Union despite the country's lengthy history of financial imprudence and default. The fact that it shares a common currency with its European compatriots prevents Greece from a unilateral devaluation, which would lessen its debt burdens.
Why not just kick Greece out of the group of euro nations and let it sink under the weight of its own financial folly? Sorry, that's complicated, too. Bond defaults would affect far more than the Greek government, Greek banks and the Greek people. These Greek bonds are held, of course, by Greek banks. But very large amounts of these issues are in the portfolios of German, French and other countries' banks as well as the European Central Bank itself. If Greece isn't saved from default, the euro countries will have to rescue these banks, whose capital would be significantly impacted by a failure of Greek debt. That Angela Merkel and Nicholas Sarkozy are advocating another Greek rescue is not out of the goodness of their hearts or some feeling of duty toward their European neighbors to the south. They are choosing what they perceive to be the lesser of the two evils.
Having received a vote of confidence in parliament this week, Prime Minister Papandreou faces the more perilous task Tuesday of winning parliamentary approval for the monumental austerity budget, the quid pro quo for the proposed bailout package. Should the austerity vote succeed, there is still the prodigious task of getting acceptance and compliance from the Greek people, who are accustomed to strong social support systems and benefits, not austerity. The presence of huge crowds in the streets and intermittent strikes testify to the difficulty of obtaining that acceptance and compliance.
European Central Bank President Jean-Claude Trichet this week described the European financial picture to be on "red alert." Closer to home, Federal Reserve Chairman Ben Bernanke said that U.S. financial interests are not significantly affected in a direct manner by a potential Greek debt default. The ripple effect, due to the impact of such a default on European banks, however, could be significant. He specifically referred to the potential deleterious effect such an event could have on even conservative investments like money market funds, which have substantial exposure to European banks.
It's hard to measure the extent to which the Greek debt crisis is weighing on the U.S. stock market. We obviously have our own debt problems here and current wrangling about the expansion of the U.S. debt ceiling is keeping our problems on the front page. It was interesting to see, however, how quickly the market reacted on Thursday to the announced agreement of the bailout package between Greece and its lenders–subject, of course, to Greek acceptance of the austerity conditions. The Dow Jones Industrial Average jumped by about 140 points in less than 15 minutes. The fact that virtually all of that gain was given back on Friday points to the probability that most of the bounce could be attributed to short covering.
Clearly the week ahead could see violent market reactions to events that those closest to the Greek situation say could go either way. Investors unable to bear the downside volatility if events unfold negatively should reduce their risk exposure. The risks are severe and there are events on the calendar that could potentially turn those risks into a negative reality. Should the European countries skate past this week's events without damage, the problems will not have gone away. They will have been deferred. Markets might react favorably to relief from immediate danger, but the overhanging debt danger will remain.