|MATTHEW CRAFT, Associated Press|
Bankers, governments and investors are starting to prepare for
The worst-case scenario envisions governments defaulting on their debts, a run on European banks and a worldwide credit crunch reminiscent of the financial crisis in the fall of 2008.
A Greek election on Sunday will go a long way toward determining whether it happens. Syriza, a party opposed to the restrictions placed on
In the meantime, banks and investors have sketched out the ripple effects if Greek were to leave the euro.
They think the path of a full-blown crisis would start in
The government resurrects the Greek currency, the drachma, and says each drachma equals
For Greeks, that would likely mean surging inflation _ 35 percent in the first year, according to some estimates. The country is a net importer, and would have to pay more for oil, medical equipment and anything else coming from abroad.
The Greek central bank would also need to print more drachmas once the country got locked out of lending markets, says
That's one reason analysts say the switch to a drachma would lead the country to default on its government debt, possibly triggering losses for the
Most assume foreign banks would have to write off loans to Greek businesses, too. Why would Greeks pay off foreign debts that effectively double when the drachma drops by half?
Say a small shop owner in
If the new currency fell by 50 percent to the euro as expected, her savings would suddenly be worth (EURO)25,000. But she would still owe (EURO)50,000 to the French bank.
European banks would take a direct blow. They've managed to shed much of their Greek debt but still held
Here's where things get scary.
"If they fail to reassure bond investors, all of the nightmare scenarios come into play," says
Experts agree that the so-called firewall built to stop the crisis from spreading needs more firepower.
Much of the (EURO)248 billion (
There's also a European Stability Mechanism that's supposed to be up and running next month, but
A fast-spreading crisis is known in financial circles as contagion _ a term borrowed from medicine and familiar to anyone who has watched a disaster movie about killer viruses on the loose.
"It's like a disease that spreads on contact," says
The bond market, where banks, traders and governments cross paths, provides the setting. If
Higher borrowing costs squeeze those countries' budgets and push them deeper into recession. Plunging bond prices imperil
At this point, the risk would be high for a run on banks throughout
"People see their banks in trouble," Shapiro says.
In less frantic times, the government would come to the rescue with cash or take over the banks. European countries have already committed to lend up to
But all this is happening in the middle of a government debt crisis, and if the crisis gets worse, the Spanish or Italian governments couldn't borrow enough cash from investors to save the day.
"They can't afford to guarantee deposits or money market balances," Shapiro says. "They don't have the ability to borrow internationally from bond markets. Where are they going to get the funds?"
From here, the crisis could easily snowball: Banks could fail, the surviving banks could stop lending to each other, and a credit freeze could shut down
One way to stem the contagion would be to create so-called eurobonds _ bonds backed by all
Cash-strapped European governments should be able to turn to the IMF for help, but the IMF's money comes from its 188 member countries. Tchir says that the U.S. and other countries may balk if the IMF asks for help supporting
"People are happy to put money in if they think they won't lose it," Tchir says. "In this case, the IMF loses money, then everybody gets scared."
A full-blown crisis would cross the Atlantic through the dense web of contracts, loans and other financial transactions that tie European banks to those in the U.S., experts say.
Blythe, the professor at
The swaps were created as a sort of insurance for loans. After lending money to a business or government, investors take out insurance on the loan. If the borrower runs into trouble and can't pay _ say, the government of
And it doesn't even take a default for a credit default swap to go bad.
If traders think other countries will follow
In the derivatives market, where credit default swaps are traded, there's a twist. When markets treat
To do that, banks cash out something else _ U.S. government debt, gold, or anything easy to sell. In normal times, it's no big deal. In a crisis, it can lead to a cascade of selling, spreading trouble from one market to another.
Another problem: It's not clear how much U.S. banks have at risk to
"You could have American banks up to their necks in CDS liabilities," Blythe says. "We don't even know."
There's a wide variety of other paths the turmoil could take into the U.S.
Money market mutual funds, which hold more than
So, what's the good news? It's hard to find anybody who believes the crisis will get that far.
The bankers planning for a Greek exit say they think European leaders will get scared into action. The Federal Reserve and other central banks learned from the financial crisis in 2008, they believe, and will jump in to stop the nightmare scenario from unfolding.
Just in case the worst comes to pass, analysts at Barclay's have attempted to estimate the fallout. They compare it to the days after the investment bank
Blythe is skeptical that it will get this bad, because he hopes the previous financial crisis has left governments and central banks prepared.
However the Greek story ends, Blythe believes it's bound to be ugly. Putting 17 countries together to share a common currency worked well when
"The euro itself," Blythe says, "is a bloody doomsday machine."
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