Fear of Greek default sends stocks plunging

September 12, 2011

— Europe’s economic crisis escalated sharply Monday as investors bet on a messy default in near-bankrupt Greece that could cost its creditors billions in losses, threatening an array of major European banks sitting on massive stockpiles of troubled debt.

Concern was mounting amid indications that European leaders — particularly in Germany, the largest donor to Greece’s bailout — may be tiring of the two-year-old fight to prop up Athens through rescue loans. Those fears drove stock markets down and sent the borrowing costs of other troubled European economies, including Italy, soaring.

The crisis was fast evolving from one that centered on the debts of profligate nations into one pivoting on the big banks that hold large amounts of those debts on their balance sheets. Underscoring the threat, France’s three largest banks — which own tens of billions of euros’ worth of bonds issued by Greece — suffered dramatic losses in share value Monday.

Some big European banks are trading at lows not seen since the height of the 2008 financial crisis, with fears growing that bad European government debt could spread through the global financial system in much the same way that bad U.S. subprime mortgages did three years ago. That could lead to another credit crunch.

After the collapse of Lehman Brothers in 2008, “banks stopped lending to each other out of fear,” said Sebastian Dullien, senior policy fellow at the European Council on Foreign Relations. “Something like that could happen again, and there are signs that the money market is freezing again. If there’s a new problem in the banking sector, we could quickly be where we were three years ago.”

In trading Monday, Germany’s DAX index shed 2.2 percent, France’s CAC 40 dropped more than 4 percent and London’s FTSE 100 dropped 1.6 percent. The Dow Jones industrial average was down for much of the day but rallied in the final minutes of trading to close up less than 1 percent.

The rebound extended to Asian markets in early trading Tuesday. Japan’s blue-chip Nikkei 225 index was up 0.3 percent in midday trading.

The European declines occurred in part because of fears that the clock might finally be running out for Greece, whose culture of tax evasion and overspending ignited Europe’s debt crisis.

Frozen out of the lending markets, Greece won a $154 billion bailout last year in the hope of avoiding a massive default with its private creditors. Unable to trim spending enough and raise taxes enough in the midst of a horrific recession, Greece persuaded the European Union, the International Monetary Fund and the European Central Bank this year to grant it a second bailout.

But that rescue still requires approval in the parliaments of all 17 nations that use the euro. And Greece has still not convinced technical officials from its three international lenders that it has a sustainable plan deserving of disbursal of even the loans approved from the first bailout.

Frustration with Greece is growing, particularly in Germany. Philipp Roesler, Germany’s economy minister, broke an unspoken taboo over the weekend by suggesting that Greece’s burdens are so great that it may need to default with its private creditors. His comments hinted at the depth of the revolt against further bailouts within Chancellor Angela Merkel’s ruling coalition at a time when polls are showing that the German public is deeply opposed to further aid.

“To stabilize the euro, we must not take anything off the table in the short run,” Roesler told Germany’s Die Welt newspaper. “That includes as a worst-case scenario an orderly default for Greece.”

Increasingly, European officials appear to be shifting the debate from how best to avoid a Greek default to how best to contain the fallout if and when it happens. Reports in Germany indicated that the government in Berlin is preparing for the worst, with officials weighing how to bolster German banks in the event of a Greek default in which investors could get back as little as half of their original investment.

Germany’s Der Spiegel magazine reported over the weekend that the Finance Ministry is working through a number of scenarios for a Greek default. Although not yet backing it, German officials were reportedly considering options in which the troubled Mediterranean nation would abandon the euro and reinstate its old currency, the drachma.

Observers suggested that the frustrated Germans may be playing a high-stakes game of chicken with the Greeks, pressuring them through tough talk to finally meet the strict budget conditions of the first bailout.

Under intense pressure to do more, the Greek government announced further measures over the weekend, including the introduction of a steep property tax. But with the recession there now projected to be far worse that predicted, Greece may miss even its newly revised targets on tax collection, and analysts were increasingly predicting a default before year’s end.

Such a default would spell trouble for the holders of Greek debt, chiefly European banks, pension funds and insurance companies. Even worse, it could spark a deeper spread of panic over the bonds of far larger European countries with high debt loads, particularly Italy, the world’s seventh-largest economy.

U.S. banks hold relatively little Greek debt, but their exposure to the debt of larger economies in Europe, including Italy and Spain, is significantly higher, and their close business relationships with European banks mean the woes in Europe could easily spread across the Atlantic.

Concern Monday focused on fear over French banks. Rumors of an imminent credit downgrade by Moody’s of France’s three largest banks — BNP Paribas, Societe Generale and Credit Agricole — sent their stocks plummeting by more than 10 percent in Paris.

Also Monday, a government-sponsored report in Britain recommended that British banks be required to take steps to shield their consumer retail operations from their riskier investment arms, potentially costing British banks more than $11 billion. The move sent an array of British banking stocks sharply down in London trading.

But some analysts suggested that banks are better prepared to deal with shocks than they were three years ago.

Hans Lorenzen, a credit strategist at Citigroup, said European and U.S. banks have reduced their reliance on short-term borrowing, which became one of the chief reasons for the last credit crunch. More importantly, central banks have new tools in place to facilitate lending that were not there in 2008 and 2009.

Yet the concern remains of a spreading contagion, starting with a Greek default.

“In that sense, it is similar to Lehman’s,” Lorenzen said. “You were concerned if Lehman’s went, how many other banks would go. . . . If Greece defaults, what’s the probability of Portugal and Ireland and then Italy and Spain?”

Special correspondent Karla Adam contributed to this report.

Anthony Faiola is The Post's Berlin bureau chief. Faiola joined the Post in 1994, since then reporting for the paper from six continents and serving as bureau chief in Tokyo, Buenos Aires, New York and London.
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