It’s been nearly two full years since Greece – a country with an economy only slightly larger than Arizona’s – rattled financial markets and put new urgency to global debt worries with looming risks of a government-bond default.
Observers fear the financial turmoil in the small Mediterranean nation could spill over to larger neighbors that aren’t much better off, especially Italy and Spain. If that happens, a broader contagion affecting banks and trade ties with Germany, France, the United States and other nations wouldn’t be far off.
“Just like Europe got caught in the backwash of the Lehman Brothers failure, some echo of that could reach us if a Greek debt default leads to the failure of a large or medium-sized European bank,” said Keith Wibel of Foothills Asset Management in Scottsdale.
The debt problems concentrated in southern Europe don’t seem likely to be resolved with quick fixes, though word of French-German progress in dealing with the crisis sparked a stock-market rally early last week.
Leaders of wealthier European nations, namely Germany and France, seem ready to bolster a fund to stabilize banks, many of which would face large losses if the Greek government defaults on its bonds. But this is probably just one step that will be needed to deal with a complicated problem.
“Policy makers still have a great deal of work to do to avoid an even larger disaster than what is already being faced,” wrote Bob Doll, a stock-market strategist at BlackRock Investments, in a recent report.
What exactly is being hammered out remains unclear.
French and German leaders “say they have agreed to something, but they won’t tell us what,” said Lawrence Fuller of Fuller Asset Management in Scottsdale. “This is cover for: ‘We need to calm the markets until we figure out what the heck to do.’ “
One dissenting and largely optimistic view is voiced by John Mathis, a professor of international finance and banking at the Thunderbird School of Global Management in Glendale.
He doesn’t think the Greek debt debacle will spill over much beyond Europe, with little likelihood of it slowing the U.S. economic recovery.
“Greece is a relatively small player in terms of economic activity,” he said. “The real economic impact is not that much.”
At its core, the debt problems in Greece reflect years of deficit spending on expenses ranging from public-sector pensions to the 2004 Summer Olympics. The Greek government wasn’t much different from those in other nations, though the numbers are proportionately larger.
Greece’s debt equals roughly 150 percent of its gross domestic product, compared with 100 percent in Italy, more than 80 percent in France and a bit less than that in the U.S., said JPMorgan Asset Management.
Greece’s inclusion in the European Economic and Monetary Union had made it easier for the country to borrow at low interest rates, though rates have since skyrocketed to reflect the nation’s heightened default risk.
That same connection to wealthier European nations makes it inconceivable for Greece to work its way out of debt by devaluing its currency, because it no longer has the drachma but instead uses the euro. Hence, the crisis has raised questions about the euro’s survival, especially if bigger nations like Italy and Spain topple.
“It’s not plausible for the Greek economy to cut its way (through unpopular austerity measures) or grow its way back to solvency,” said Wibel, who thinks Greece eventually will leave the eurozone.
A Europe-wide solution might be needed. Possible remedies include having stronger European nations buy at least some of the Greek bonds held by banks and taking other steps to cushion them from the capital drain posed by a Greek debt default.
“Progress has been slow, and consensus hard to come by, but we still see the ultimate endgame being a program modeled after our Troubled Asset Relief Program,” Fuller said.
Mathis expects some Greek debt will be restructured with lower interest rates and longer maturities and some will be written off as uncollectible.
Kindling optimism last week was hope that European leaders finally were preparing to take decisive action. But like an ancient Greek drama, this story could have many more plot twists and turns.
Greece already is in recession, and a Europe-wide slowdown could be next.
“It now seems to be an almost foregone conclusion that Europe is headed for a recession,” Doll wrote, adding that he thinks the U.S. can avoid one.
Nor does Fuller predict the U.S. will slip into a new recession; he expects the impact will be borne mainly by Europe.
Mathis also predicts the U.S. will avoid a recession, citing signs such as rising business investment and stable consumer spending.
Still, the deleveraging trend already under way in the U.S. could keep the economy growing at a subpar pace for maybe three more years, he said.
It remains to be seen exactly how exposed banks are to Greece’s bad debt – and which banks. This uncertainty is hanging over the financial markets like the mythological Greek sword of Damocles.
Conversely, expectations are so low that any favorable developments could provide a huge lift, as happened last week.
“We believe the markets have already priced in a high likelihood of (a Greek) default,” Doll wrote.