Greek default fears are starting to infect Germany and its banks, which have significant holdings of Greek sovereign debt. And the infection is spreading to the U.S. because of close connections between U.S. and German banks.
International loans to Greece are in jeopardy because the aid is conditioned on deficit reduction and other fiscal reforms. The Greek government is not moving quickly enough for its foreign benefactors, but even those thin budget cuts threaten the country’s stability. Greek workers on the government payroll, including garbage collectors and doctors, are striking in protest of austerity measures that are hitting their paychecks. Homeowners face record high property taxes and restaurant goers face a new sales tax on their meals.
The measures are intended to smooth the release of an 8 billion euro piece of the 110 billion euro bailout loan package that was promised last year—but which is contingent on Greece getting its financial house in order.
German bank stocks took a dive last week, bringing Wall Street along for the ride, because of exposure to Greek debt at European and American banks. The slide started after Bloomberg reported that the German government had a plan B to rescue its banks in the likely event of a Greek default. Banks could face losses of up to 50 percent on their holdings of Greek debt if the latest loan component is withheld.
The terms of the bank rescue plan were not released, but talk about forced recapitalization has been growing in recent weeks. In a recapitalization, an insurance fund—which could be funded by government or private investors—guarantees bank deposits by covering the difference between the book and market value of the bank’s assets. The insurance fund could take an equity position in the bank in exchange for the assistance.
Earlier this month, International Monetary Fund Managing Director Christine Lagarde called for “mandatory substantial recapitalization—seeking private resources first, but using public funds if necessary.”
As reported by AdvisorOne’s Gil Weinreich, German banks are exposed to about $40 billion in Greek sovereign debt. But they hold almost $700 billion in PIIGS (Portugal, Ireland, Italy, Greece, and Spain) debt. Greek default likely would jeopardize access of the other PIIGS countries to the capital markets, bringing the sovereign debt of the other PIIGS along for the ride.
U.S. markets, led by domestic banks, have about $600 billion in exposure to Germany, largely through swap contracts with German banks.
Despite being only the 32nd ranked country in terms of GDP, a Greek default would ripple across the world economy and could spark a new financial crisis. And there’s no sign that Greece is willing, or able, to take the kind of action necessary to shore up its economy long-term.
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See also The Law Professor’s blog at AdvisorFYI.