Maine news, sports, weather from Portland Press Herald / Maine Sunday Telegram, Portland, Maine

June 16, 2012

Wall Street braces for chaos if Greece exits euro

Stocks and oil would sink and the euro would fall against the dollar, banks and investors predict.

The Associated Press

NEW YORK - The unthinkable suddenly looks possible.

Bankers, governments and investors are starting to prepare for Greece to stop using the euro as its currency, a move that could spread turmoil throughout the global financial system.

The worst-case scenario envisions governments defaulting on their debts, a run on European banks and a worldwide credit crunch reminiscent of the financial crisis in the fall of 2008.

A Greek election Sunday will go a long way toward determining whether it happens. Syriza, a party opposed to the restrictions placed on Greece in exchange for a bailout from European neighbors, could do well.

In the meantime, banks and investors have sketched out the ripple effects if Greece were to leave the euro.

They think the path of a full-blown crisis would start in Greece, quickly move to the rest of Europe and then hit the U.S. Stocks and oil would plunge, the euro would sink against the U.S. dollar, and big banks would uncover losses on complex trades.

ACT I

In the worst-case scenario, Greece's exit starts off messy.

The government resurrects the Greek currency, the drachma, and says each drachma equals one euro. But currency markets would treat it differently. Banks' foreign-exchange experts expect the drachma would plunge to half the value of the euro soon after its debut.

For Greeks, that would likely mean surging inflation -- 35 percent in the first year, according to some estimates. The country is a net importer, and would have to pay more for oil, medical equipment and anything else coming from abroad.

The Greek central bank would also need to print more drachmas once the country got locked out of lending markets, says Athanasios Vamvakidis, foreign exchange strategist at Bank of America-Merrill Lynch in London.

Greece's government and banks currently survive on international aid. "Without access to markets, they have to print money," he says.

That's one reason analysts say the switch to a drachma would lead the country to default on its government debt, possibly triggering losses for the European Central Bank and other international lenders.

Most assume foreign banks would have to write off loans to Greek businesses, too. Why would Greeks pay off foreign debts that effectively double when the drachma drops by half?

Say a small shop owner in Athens has a 50,000-euro business loan from a French bank. She also has 50,000 euros in savings in a Greek bank. The Greek government turns her savings into 50,000 drachma.

If the new currency fell by 50 percent to the euro, as expected, her savings would suddenly be worth 25,000 euros. But she would still owe 50,000 euros to the French bank.

European banks would take a direct blow. They've managed to shed much of their Greek debt but still held $65 billion, mainly in loans to Greek corporations, at the end of last year, according to an analysis by Nomura, a financial services company. French banks have the most to lose.

ACT II

Here's where things get scary.

The European Central Bank and European Union would have to persuade bond investors that they will keep Portugal, Spain and Italy from following Greece out the door. Otherwise, borrowing costs for those countries would shoot higher.

"If they fail to reassure bond investors, all of the nightmare scenarios come into play," says Robert Shapiro, a former U.S. undersecretary of commerce in the Clinton administration.

Experts agree that the so-called firewall built to stop the crisis from spreading needs more firepower.

Much of the $310 billion left in the European Financial Stability Facility, one European bailout fund, was pledged by the same countries that may wind up needing it, Vamvakidis says.

(Continued on page 2)

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