Tags: Greece | Economy

John Mauldin: Greek Default Would Threaten US

Sunday, 29 May 2011 11:01 AM

By Forrest Jones

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Any default in Greece would pummel not only the economy there but spread across Europe and eventually to the United States, inflicting economic damage similar in speed to the subprime housing crisis from just a few years ago, says financial expert and author John Mauldin.

The problem, Mauldin tells Yahoo! Daily Ticker, is that banks all across Europe are exposed to Greece.

Should Greece default on its debt, the country would likely convert back to the drachma. Immediately, all bank depositors would default Greece, Economyon their debts due to the sudden weakening of their currency.
French and German banks would then write down their Greek exposure, and so would the European Central Bank (ECB).

On top of that, U.S. banks have been taking on risk in Europe via writing credit default swaps, instruments made famous during the U.S. housing meltdown that are basically insurance policies against defaults.

The result: everyone takes a hit.

"You're only balanced as long as both of those counter parties are good," Mauldin says, describing how a U.S. bank could suffer from European exposure.

"If you have a bad counterparty, you're out of balance and just like the subprime crisis didn't stop in California--it went to New York and all of the world – I'm worried that this one has a lot of contagion and it will infect the world."

Fixing the Greek and other economies may prove to be a tough task, as it could involve outsiders stepping in and dictating to Athens how to direct its economic affairs.

"In essence, if you've read three or four of the major leaders, what they've said is that Greece and Portugal and some of the other countries may have to give up some of their sovereignty and we may need to come in a take control," Mauldin says.

"I don't know how that's going to play to the Greek and Portuguese voters."

Moody's Investors Service has said longer the issue drags on, the more likely things will turn ugly.

"It is apparent that the longer the current state of uncertainty affecting Greece persists, the greater the temptation on the part of both the Greek and the euro area authorities to try to undertake some form of debt restructuring – in other words, to allow Greece to default," the agency says in a statement.

Although Greek government officials won't throw their hands up in the air and scream "we're defaulting," other keywords they use should make market watchers very nervous in the mean time.

"A Greek default might take many forms, including changes in terms and conditions, selective 're-profiling' and large-scale 'voluntary' debt buybacks at high discounts, which Moody's classifies as distressed exchanges."

Some experts say Europe should give Greece some room to work itself out of its debts, as the possibility that contagion will arise and hurt the world's recovering economy is rather minimal.
Nouriel Roubini, the New York University economist who accurately predicted the magnitude of the housing meltdown and ensuing recession, is one of them.

"The ECB and other commentators have raised the specter that a debt restructuring in Greece would lead to massive and destructive contagion to financial markets, banks and financial institutions and other [euro zone] sovereigns that would in turn lead to financial disaster," Roubini says on the economonitor.com web site run by his research firm, Roubini Global Economics.

"An objective analysis and pre-emptive, orderly debt rescheduling would actually mitigate rather than exacerbate the risks of contagion, contamination and moral hazard."

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