Have Europe’s leaders kicked the Greek can as far as it will go?
Unnervingly, it is starting to look like the answer may be yes. Policymakers this week failed yet again to take decisive action on Greece’s debt crisis, rattling markets and prompting billionaire George Soros to brand officials' failure to restructure Greek debt a “mistake.”
The central problem -- beyond Greece's running out of money again -- is a standoff between bailout-shy politicians and instability-fearing central bankers. The assumption has been that they would come to their senses and make a deal to forestall catastrophe.
But their little game of chicken souvlaki now threatens to jolt Europe and perhaps the world with a new financial disaster.
On cue, Moody’s warned Wednesday that a Greek default – which is looking likelier by the day -- could ripple across the European banking system. It put three big French banks on review for a possible downgrade and warned that other reviews may follow.
“We are closely monitoring the risks that would likely result from a Greek default scenario,” Moody’s said in announcing its review of Credit Agricole, BNP Paribas and Societe Generale. It noted “the potential impact on weaker countries, the capital markets, and funding conditions,” and said it is “taking those risks into consideration in our ratings of banks across the Eurozone.”
Markets, after ignoring the Greek time bomb for months, are starting to act appropriately terrified. U.S. stocks declined again Wednesday, as the dollar rose against the euro. Government bond prices across Europe’s troubled periphery continued to sink.
The latest sovereign bond selloff took the yield on 10-year debt to 18% in Greece, 12% in Ireland and 11% in Portugal. So much for the bailouts of those countries lifting the siege mentality.
But potentially more troubling is the action in Spain. The 10-year yield remains a modest 5.55%, but the spread to German government bonds – a measure of the two issues’ relative risk -- has risen by half a percentage point in two months.
Spanish credit default swaps were by far the most actively traded over the past week, notes Gavan Nolan of data provider Markit, with some $8.3 billion worth of default bets being made – more than twice as much as was wagered on also-ran Italy.
The market tremors come at a time when it is looking like policymakers in Europe may have fallen disastrously behind the threat they have spent the past year trying to contain.
European leaders are trying to agree on terms of further aid to Greece by next week’s summit in Brussels. The deadlock isn’t playing well in Athens, where the austerity plans that came with the first bailout last year have failed to produce the promised results. Rioters attacked police there Wednesday.
Seeing the taxpayer bill mounting, German politicians are calling for private sector bondholders to accept longer repayment terms. Jean-Claude Trichet, the head of the European Central Bank, has been warning that the debt maturity extension being pitched by German leaders is untenable because it could set off unpredictable forces in the markets.
But with the markets putting 3 in 4 odds on a Greek default within five years and nearly 50-50 odds on defaults in Portugal and Ireland, it seems clear that many of those forces already have been unleashed.
The risk now is that the time policymakers have been playing for has passed and a bank run like the ones seen in Ireland and Greece will now descend on other weaker economies, notably Spain.
It is still possible that the Europeans can come to grips with this crisis before we end up in a replay of Lehman Brothers. But in a depressing replay of 2008, for now it seems that the flavor of the day is wishful thinking.