Greek Default Looms; Markets Hold Steady

Banks seen as undercapitalized if default occurs

Markets around the world steadied on Friday in Europe, despite rumors of an imminent Greek default. Stock markets in Europe showed modest gains after roller-coaster trading, while U.S. markets held steady.

Adding to worries was talk that Europe's banks are undercapitalized, thus facing far greater losses than originally expected if Greece fails to pay its debts and other eurozone countries follow suit.

Exchanges from Asia to Europe feel by afternoon, but rallied to post modest gains, with the DAX and the CAC both up about 30 points. The Nikkei was closed for a holiday. In the U.S., the S&P finished up 6.85, the Dow up 37.65 and the Nasdaq up 27.56.

Reuters reported that the International Monetary Fund (IMF) believes Europe's banks need to beef up their capitalization by some 200 billion euros ($265.356 billion) if Greece defaults and other countries in the euro zone with financial woes, such as Italy and Ireland, follow suit. Analysts believe the situation is even worse.

Barclays Capital puts the figure at 230 billion euros to maintain a 6% core Tier 1 capital ratio if, in a worst-case scenario, the debts of Greece, Ireland, Italy, Portugal and Spain (GIIPS) are written down by 50%. Credit Suisse is even more pessimistic, calculating that a total of 400 billion euros in additional capitalization will be needed by 2012 to account for losses from sovereign debt, the recession, and higher funding costs.

Such woes, added to the increased prominence of talk about a Greek default, and a lack of confidence in G20 assertions that member nations would take whatever steps were necessary to reassure markets as the euro zone strengthened its bailout fund, made the day promise to be a down ending on an already troubled week.

Greek Finance Minister Evangelos Venizelos was quoted by two newspapers, according to the report, saying that a 50% haircut for bondholders was one of three likely scenarios to address Greece's financial situation. He also called those newspaper reports an unhelpful distraction.

Klaas Knot, a member of the European Central Bank governing council, openly addressed the subject, the first time an ECB policymaker has done so. In the Dutch daily Het Financieele Dagblad, he was quoted saying, "It is one of the scenarios. I'm not saying that Greece will not go bankrupt. All efforts are aimed at preventing this, but I am now less certain in excluding a bankruptcy than I was a few months ago." He added that he wondered "whether the Greeks realize how serious the situation is."

The dismissal of G20 words as hollow was widespread. Andrew Lim, banks analyst at Espirito Santo, was quoted saying, "It's the usual platitudes ... but they don't have the political capital to do what they need to do, which is bail out the southern European countries and recap all the banks. I think it's a complete nonsense. The short-term funding market is dying for some banks, and the wholesale funding market has also pretty much dried up."

He pointed out that French, Italian and Spanish banks were all at risk, and although some daring bargain-hunters were going long-only for the sector, most others, including hedge funds, were sitting it out.

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