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Weekly Focus: Default Lines

Greece continues to trouble the equity markets, with the drip, drip, drip of frightening newsflow on the country’s economic picture making it largely impossible for share prices to progress.

There is no doubt Greece is in a mess. Its government is trying to step up its €28bn (£25bn) programme of spending cuts and tax increases but cannot persuade anyone to buy into the increase. Its citizens have already taken to the streets in protest. Its eurozone peers are tiring of its economic, political and social mismanagement.

Most commentators now believe that a default is inevitable, arguing Greece simply cannot afford to pay back its debt. The real question, they say, is how this default will be managed by the eurozone powers.

The consequences of a default are wide-ranging and unpredictable. The first worry is its potential impact on the region’s banking system. Greek assets are held by banks all over Europe and a default therefore profoundly threatens their stability. There have been reports UK banks are already pulling away from unsecured lending to eurozone banks, threatening another credit crunch and possibly a banking default.

This has led to talk of another ‘Lehman style’ crisis. It may be cold comfort, but at least if a default were to happen it would have been widely expected. Few will be left holding exposed positions and be able to say they did not realise default was likely. In contrast, the collapse of Lehman Brothers was a genuine shock as many presumed it would be rescued – right up to the point at which it was not.

With Greece, there is also the contagion problem. If the country were to default, would Portugal and Ireland want to do likewise? Would it make debt repayments prohibitively expensive for, say, Spain or Italy? Again, this would be destabilising not just for the countries themselves but for any holder of their assets. In this way, a Greek default could have widespread repercussions.

In some respects, the obvious solution would be for Greece to leave the euro. It could then devalue its currency and regain some of its long-lost competitiveness. This has, however, been seen as an unacceptable route for a number of reasons – Greek assets would instantly devalue significantly, which brings into play all the contagion problems mentioned earlier. It is of course also a more politically difficult solution and would involve a lot of policymakers admitting they had made a mistake.

Ultimately, eurozone policymakers are faced with a lot of very unattractive options. There is no easy way out of Greece’s problems. Markets recognise this and only a clearer picture on Greece’s future is likely to propel them forward once again.

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