A Greek Default Would Spread Debt Contagion

European leaders insist they will take all necessary measures to ensure Greece does not default on its debt. A default would throw Greece's economy — and the European banking system — into deeper crisis. But many financial experts are advocating an orderly default. They argue it will be painful but preferable to round-after-round of painful austerity measures and more uncertainty.

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STEVE INSKEEP, Host:

NPR's business news starts with Europe again shaking financial markets.

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INSKEEP: American stock prices are holding steady today after the big selloff yesterday, but market sentiment remains uncertain. There are increasing worries that economies will fall back into recession around the world. Markets across Asia ended lower, European markets, mostly mixed. Earlier today, leaders of the G20 - the world's largest economies - issued a statement saying they will do whatever is necessary to stabilize banks and financial markets.

But also today, the ratings agency Moody's downgraded eight Greek banks, and that added to the fear. The fear is that Europe's banks are holding too much Greek government debt and that if Greece defaults on those debts, banks would take a huge hit. We have more now from NPR's Eric Westervelt.

ERIC WESTERVELT: We have a pretty good idea what a default, if it happens, might mean for the Greek people: more financial pain, on top of the unprecedented number of layoffs, tax increases, spending and pension cuts already imposed. Yet a growing number of Greeks, including lawyer George Katrougalos, think that despite the risks, a default offers a way out of the cycle of austerity, hardship and zero growth.

GEORGE KATROUGALOS: Default would be better. Maybe the next year is going to be, if we default, even harder than what we are facing today. But we can start without this heavy burden of the debt.

WESTERVELT: There'd almost certainly be a run on Greek banks, some or all of which would likely have to be nationalized - for at least the short term - to rebuild. If Greece were forced out of the eurozone, inflation would skyrocket. That much is relatively easy to gauge. But calculating the impact of a Greek default on banks in Europe and beyond is far more complex.

The think tank Open Europe estimates that if just half of Greece's debt is written off in a restructuring, it will cost the European economy upwards of $200 billion. But economic analyst Raoul Ruparal with Open Europe says that educated guess only takes into account the first wave.

RAOUL RUPARAL: Any attempt to estimate exposures only scratches the surface of the real potential fallout from a default or restructuring of Greece.

WESTERVELT: Almost unknowable bigger costs, Ruparal says, would come from the contagion that might spread across Europe's interconnected banking system and even the U.S. banking sector, as well. European banks' exposure to bad Greek debt may be higher than it seems on the surface. That's because banks may own Greek debt directly and also be exposed through the two Greek bailout funds. France appears to be the most at risk.

Bloomberg News reports that as of the end of March, French financial firms had more than $670 billion invested in public and private debt in Greece, Portugal, Ireland, Italy and Spain. That's the biggest exposure to the euro area's debt-troubled countries, and almost a third more than German lenders' exposure.

Analyst Ruparal notes that the European Central Bank is exposed, as well, though it's not clear how much. It doesn't disclose which countries it buys from, and the amount is constantly in flux. But the ECB has reportedly been buying up Greek bonds during the crisis.

RUPARAL: The knock-on effects and the second-round effects of a default which would ultimately cause liquidity and credit to freeze up in the whole of the financial market in Europe, possibly, and the knock-on costs of this and possibly other defaulting loans from banks across Europe would be almost impossible to chart.

WESTERVELT: The fear is that the contagion would spread from the banks into other parts of the economy. For example, a credit crunch would hurt export-dependent Germany and its important Mittelstand companies. These are often small and mid-sized family-run, specialty firms that form the foundation of German industry. Eberhard Vogt is with the German Mittelstand Business Association.

EBERHARD VOGT: (Through translator) We are expecting another European credit crunch from this, and it will seriously affect us. Without a reliable credit flow, we fear massive problems for the German Mittelstand.

WESTERVELT: Despite the risks, Vogt's group is now advocating an orderly, partial Greek default. He says constantly throwing new cash after bad money is not a long-term solution. More and more economists agree a partial or full default, if done carefully, would be better than the death-by-a-thousand-cuts approach Europe is now taking. Raoul Ruparal with Open Europe.

RUPARAL: The longer we wait and the more bailouts that have been given, the more risk taxpayers will be taking on. So if we think two, three years down the line after a second bailout, there could be an extra one hundred billion or so on the books of taxpayers and EU institutions. And I think, given the situation, it looks to be much fairer and much more efficient for the write-downs to be taken now and for the private sector and the banking sector to share in the burden.

WESTERVELT: There eurozone has little time to waste. The European Central Bank's own economists this week wrote that fiscal imbalances in the euro area, the dire situation in individual member countries risk undermining stability, growth and employment, as well as the sustainability of the monetary union itself. Eric Westervelt, NPR News, Berlin.

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