The LookoutCould Greece’s troubles wreck the American economy?
Just when we were finally getting a few glimmers of positive economic news, Europe's debt crisis has reared its head again. U.S. stocks, which had rallied in recent weeks, nosedived today, after investors were spooked by an announcement that Greece will hold a referendum on whether to accept a European bailout.
What's the likely result of the turmoil? And what might it end up meaning for the still struggling American economy? Here's what you need to know:
I thought Europe just agreed to bail Greece out again? What's the problem now?
Last week in Brussels, European officials and leaders of the International Monetary Fund came together on a plan to cut Greece's enormous public debt in half, and to set up a $1.4 trillion fund to prevent Greece's woes from spreading to other troubled European economies.
But the plan contains harsh and unpopular austerity measures, in the form of spending cuts and tax hikes designed to address Greece's long-term fiscal health. Greek Prime Minister George Papandreou Monday shocked Europe's leaders by announcing he would put the issue to a national referendum. "If the people do not want it, then it shall not be implemented," said Papandreou. "If yes, we shall proceed."
So are Greek voters likely to approve the plan? What if they don't?
Opposition to earlier austerity measures, undertaken at the insistence of foreign lenders, sparked violent riots in Athens earlier this year. It's far too soon to say with much confidence, but a 'no' vote looks like a real possibility. In addition, Papandreou's coalition governing appears shakier than ever. If it collapses -- a real possibility right now -- then all bets are off for the Brussels debt pact.
If the bailout-for-austerity deal isn't enacted, it's possible that Europe's leaders, facing few options to prevent a Greek collapse, could offer the bailout funds anyway. But there's no guarantee, and without a bailout, Greece would likely default on its debt and go into bankruptcy. If that happened, it might be forced to leave the eurozone.
How would that affect the rest of the world?
A Greek default could threaten other eurozone nations--Portugal, Ireland, Spain, and Italy, primarily--simply by reducing investor confidence more broadly, sparking a stampede away from economies perceived as risky.
One analyst recently likened the situation to the 2008 failure of Lehman Brothers, which sparked the near-collapse of the entire financial system. "You were concerned if Lehman went, how many other banks would go," Hans Lorenzen, a credit strategist at Citigroup, told the Washington Post last month. "If Greece defaults, what's the probability of Portugal and Ireland and then Italy and Spain?"
Italy is Europe's third largest economy, so an Italian default could reverberate more widely across the continent. That's why when President Obama goes to the G-20 summit of word leaders in Cannes, France, this week, he is expected to press European leaders to make clear that they'll guarantee the debts of Italy and Spain.
Even relatively healthy economies, like those of France and Germany, could be at risk, in part because in those two countries banks hold a total of $54 billion euros of Greek debt. Last month, credit ratings agency Moody's downgraded the ratings of two large French banks, citing concerns over their exposure to Greek debt.
What about the United States?
American banks don't have much exposure to Greek debt. But if European credit markets seize up, that could cause a chain reaction that reaches the United States--a rough reversal of what happened in 2008, when the near-failure of the U.S. banking system quickly caused Europe's credit to freeze.
That's a worse-case scenario. More likely is that uncertainty about the European crisis continues to weigh down the American stock market and dent business confidence, exerting an ongoing drag on the economy--just when it might otherwise be gaining some momentum.
How did we get to this point?
The Greek government's excessive public spending, combined with a culture of tax evasion and the global economic downturn (not to mention a helping hand from Goldman Sachs), created a public debt so high that investors began to lose confidence the country could repay its creditors. That made it much more expensive for Greece to finance new borrowing, further reducing its ability to repay the original debt.
Last year, the European Union and the IMF gave Greece a $154 billion bailout, also with tough austerity measures attached. But that hasn't been enough to restore investor confidence -- hence the desperate effort last week in Brussels to piece together a new deal.
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