Greek Default Could Spur Europe-Wide Contagion

A protester waves the national flag of Greece during a demonstration Tuesday at Athens' Syntagma square in front of the Greek Parliament. Demonstrators have been camped outside Parliament since May 25. i i

A protester waves the national flag of Greece during a demonstration Tuesday at Athens' Syntagma square in front of the Greek Parliament. Demonstrators have been camped outside Parliament since May 25. Lefteris Pitarakis/AP hide caption

itoggle caption Lefteris Pitarakis/AP
A protester waves the national flag of Greece during a demonstration Tuesday at Athens' Syntagma square in front of the Greek Parliament. Demonstrators have been camped outside Parliament since May 25.

A protester waves the national flag of Greece during a demonstration Tuesday at Athens' Syntagma square in front of the Greek Parliament. Demonstrators have been camped outside Parliament since May 25.

Lefteris Pitarakis/AP

Greece's day of reckoning is very nearly at hand.

Bright anger has spilled onto the street, as the country tries to dig its way out of an economic crisis. Prime Minister George Papandreou's government survived a key confidence vote, which he had called to help him pass deeply unpopular austerity measures. European Union ministers have threatened to cut off billions in bailout money if Greek legislators don't pass wage cuts and other painful austerity steps.

Greece needs that $17 billion infusion from the EU and the International Monetary Fund by mid-July or it risks going into default — the eurozone's first. Experts say the country's options are limited and that default could produce something resembling panic.

"You would see a run on the banks, I think," said Lee Buchheit, a partner at Cleary Gottlieb Steen & Hamilton who advised Uruguay during a similar economic crisis.

  • ARGENTINA, defaulted in 2001. Argentines try to break down a metal wall at a bank in Buenos Aires in 2002 to protest the government-imposed blockade that had prevented access to their savings since the beginning of December 2001.
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    ARGENTINA, defaulted in 2001. Argentines try to break down a metal wall at a bank in Buenos Aires in 2002 to protest the government-imposed blockade that had prevented access to their savings since the beginning of December 2001.
    Ali BurafAFP/Getty Images
  • ECUADOR, defaulted in 1999, 2008.  A woman exchanges Ecuadoran sucres for U.S. dollars at the Central bank in Quito in 2000. Ecuador switched to dollars after its currency devaluated greatly in 1999 and fell 23.5 percent in the first week of 2000.
    Hide caption
    ECUADOR, defaulted in 1999, 2008. A woman exchanges Ecuadoran sucres for U.S. dollars at the Central bank in Quito in 2000. Ecuador switched to dollars after its currency devaluated greatly in 1999 and fell 23.5 percent in the first week of 2000.
    Martin Bernetti/AFP/Getty Images
  • INDONESIA, defaulted in 1998. Indonesian miners carry bags of mud to be filtered for gold at the Aneka Tambang gold mining site in 1999. Hundreds of gold miners had been digging at the state-owned mining site without a permit since an economic crisis hit the country in 1997 and again the following year.
    Hide caption
    INDONESIA, defaulted in 1998. Indonesian miners carry bags of mud to be filtered for gold at the Aneka Tambang gold mining site in 1999. Hundreds of gold miners had been digging at the state-owned mining site without a permit since an economic crisis hit the country in 1997 and again the following year.
    Weda/AFP/Getty Images
  • NIGERIA, defaulted in 2002. Police officers mount a barricade at the Labour Secretariat in Abuja to stop workers from marching in the street in 2004 amid continued economic woes. Nigerian trade unionists had gathered in the capital to protest rising fuel prices and mobilize support for an imminent general strike.
    Hide caption
    NIGERIA, defaulted in 2002. Police officers mount a barricade at the Labour Secretariat in Abuja to stop workers from marching in the street in 2004 amid continued economic woes. Nigerian trade unionists had gathered in the capital to protest rising fuel prices and mobilize support for an imminent general strike.
    AFP/Getty Images
  • RUSSIA, defaulted in 1998.  A homeless man sleeps in the window of an antiques shop on downtown Moscow's Arbat street. Although Prime Minister-delegate Yevgeny Primakov had said during Russia's ruble crisis that reform was at the top of his economic priorities, the country ultimately defaulted.
    Hide caption
    RUSSIA, defaulted in 1998. A homeless man sleeps in the window of an antiques shop on downtown Moscow's Arbat street. Although Prime Minister-delegate Yevgeny Primakov had said during Russia's ruble crisis that reform was at the top of his economic priorities, the country ultimately defaulted.
    Alexander Nemenov/AFP/Getty Images
  • URUGUAY, nearly defaulted in 2003.  Letisia Rodriguez, 18, and Ernesto Baez, 24, collect bottles, cardboard and food they find in a garbage dump in Montevideo. The economic crisis that affected Uruguay increased unemployment, forcing some Uruguayans to root through garbage to sustain their families.
    Hide caption
    URUGUAY, nearly defaulted in 2003. Letisia Rodriguez, 18, and Ernesto Baez, 24, collect bottles, cardboard and food they find in a garbage dump in Montevideo. The economic crisis that affected Uruguay increased unemployment, forcing some Uruguayans to root through garbage to sustain their families.
    Marcelo Hernandez/AP

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Economists say bank lending could grind to a halt and that Greece — or perhaps the whole EU — could be thrust into a double-dip recession.

For all the scrambling, there's little surprise that Greece stands on the precipice of financial collapse. Athens turned to the IMF last year for a line of credit to pay bondholders, and the country has been in default more often than not during the past two centuries. In fact, what could be considered the first sovereign debt default took place in Greece in the fourth century B.C. when municipalities in the Attic Maritime Association missed payments to the Delos Temple, according to the IMF.

The Aegean nation is hardly alone. Notably, Russia defaulted during the "ruble crisis" of 1998, and since then, a dozen other countries have either missed or come close to missing payments to foreign bondholders — Pakistan, Indonesia, Ecuador and Moldova more than once.

Greece Is No Uruguay

The process of recovery can be painful, and some countries come back from the brink sooner than others.

Uruguay, which nearly defaulted in 2003, became a "classic case of a country that did the right thing," Buchheit said.

Before it missed any payments, Uruguay went to its creditors and worked out a plan to extend the terms of its loans for a few years, an adjustment known as reprofiling. Within a few weeks, the country was back on firmer financial ground.

"Officials in Uruguay said, 'Look, read the numbers and you will see that we run out of gas very soon unless we can move this debt stock down the road,' " Buchheit said.

But Greece is no Uruguay. For one thing, Uruguay, like other countries, devalued its currency as a way to recover its competitiveness and export revenues. A cheap currency makes goods produced in a country easy for other nations to buy.

Debt Crisis Case Studies

Russia: Defaulted In 1998

Causes: Artificially high ruble, chronic fiscal deficit, flucuations in price oil, Russia's chief export, cost of the war in Chechnya.

Outcome: Moscow declared a 90-day moratorium on payment to foreign creditors and floated the ruble, effectively devaluing it. By 2000, thanks in part to recovering oil prices, Russia was able to bounce back.

Argentina: Defaulted In 2001

Causes: The trouble in Russia helped sour investors on Argentina and other emerging markets. Artificially high value of the Argentine peso (fixed at 1 to 1 to the U.S. dollar). Chronic high unemployment helped lead to a loss of confidence and a run on banks by individuals wanting to convert pesos into dollars to send to safe havens abroad.

Recovery: Government froze all bank accounts for 12 months, leading to civil strife. It also ended convertibility for the peso, effectively devaluing it. The devalued peso discouraged imports while a rise in the price of soy and other exports helped bring in export revenue. By 2005, the country had largely rebounded.

Uruguay: Reprofiled Debt In 2003

Causes: A knock-on effect from economic problems in Argentina and Brazil. Unemployment, inflation and the burden of external debt all rose sharply.

Recovery: Uruguay pre-emptively went to creditors to ask for a five-year extension in repayment terms. Within a year, the country's economy bounced back and was able to meet the new terms of its restructured debt.

Sources: Bank of England; This Time is Different Chartbook: Country Histories on Debt, Default, and Financial Crises

"The Greeks can't do that because they're in the EU monetary union," Buchheit said. Non-EU countries can just print more money, but Greece doesn't have sole control over the euro printing press.

To make exports cheaper, Greece would have to lower wages, reduce pensions and strip away subsidies — deeply unpopular moves that have resulted in social unrest and austerity strikes. But even if Greece finds the political will for such severe cuts, it won't come soon enough to guarantee that Athens won't miss a payment on its sovereign debt.

Experts say Greece essentially has three options: a full-on default in which the country misses a payment to creditors; a structured default a la Uruguay, where terms of loans are extended; or yet another bailout that allows Athens to keep paying on its obligations on the current terms.

Fears Of Contagion

Most economists think the bailout option is the only realistic scenario if the EU is to avoid a contagion effect that could further weaken strapped eurozone economies such as Italy, Ireland, Portugal or Spain.

A default or even a restructuring of Greece's debt could spook investors and cause them to stop lending to those other suspect countries, said Jacob Kirkegaard, a former Danish government official and senior staff member at the Peterson Institute for International Economics.

That, in turn, would drive up the cost of borrowing for those economies. "The higher cost of borrowing leads to more austerity, slower rates of growth and perhaps even a double-dip recession," he said.

Worse still, it could precipitate collapse in Spain — whose economy is much larger than Greece's.

"There isn't enough money in the system to bail out Spain," Kirkegaard said. "The country is too big and it would require too much capital. The Europeans don't have it, and I would contend that even the IMF doesn't have that kind of money."

One thing Greece could do is "sell off its crown jewels by privatizing government assets," said Eswar Prasad, a professor of trade at Cornell University and a senior fellow at the Brookings Institution. "But everyone is going to recognize it as a fire sale, so the question is how much money they could raise."

For now, however, the EU has little choice but to keep propping up Greece, Kirkegaard said.

'Games Of Chicken'

Even if Athens gets another bailout installment and pays maturing bonds on time and in full, it's not off the hook because it will still have to dig deep to pay back the EU and IMF.

Ways Out

  • Reprofiling: Not technically a default. Instead, a country agrees to a pre-default restructuring that typically extends the repayment terms without changing the interest or principal on bonds. Uruguay successfully reprofiled its sovereign debt in 2003.
  • Default: Occurs when a country misses a bond payment. Most often, it leads to renegotiating the terms of loans, lowering the principal and/or interest charged.
  • Some nations, especially after civil wars or similar political upheavals, have written off their debt entirely. Cuba after Castro's revolution and China after the Communist revolution are two examples. A period of long economic isolation typically results after a country writes off its obligations.

Kirkegaard sees a lack of political will in Greece to impose the type of spending cuts and tax increases needed to shrink the debt — a situation he likens to what's happening in the U.S. However, he was quick to note that U.S. economic problems are "in no way" near those of Greece.

"I think in many ways, the kind of political brinkmanship and games of chicken that are being played out right now in the eurozone between the Greek government and the EU ... will be repeated in the U.S. about a month from now" when the showdown over the debt ceiling occurs," Kirkegaard said.

"Then the kind of dynamic is the same," he said. "You can only take the painful political decision at the stroke of midnight."

The good news for Greece is that if it can manage to get its fiscal house in order, debt markets are likely to be "extraordinarily forgiving," said Prasad of the Brookings Institution.

"Many countries have been able to get private financing just a couple of years after defaulting: Argentina, Russia," he said. "But they had to restore competitiveness and get back to decent growth for that to happen."

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