For more than a year now the economic crisis in Greece has been a prominent feature in international financial publications. Greece is one of the smaller countries in the European Community (EC), but it is also one of the most highly indebted (followed closely by Ireland, Italy, Portugal and Spain). The Greek national debt-to-GDP ratio stands at about 120 percent, and the budget deficit of 12.7 percent and growing has placed its fiscal position in jeopardy.
The country is on the path to defaulting on its debt payments by the end of the year, unless it is able to secure parliamentary approval for a bail-out package which was designed by the European Union and the International Monetary Fund (IMF).
A key question is why should the economic problems of one relatively small European country (the 27th largest economy in the world) be of concern to other countries or to investors in those countries? The simple answer might be globalization of the financial markets - the interconnectivity of the world's financial institutions and the investors who use them.
The Greek sovereign debt crisis has implications for other countries because that debt, mostly in the form of Greek government bonds denominated in euros, is held by banks in Spain, Portugal, Germany and other European, and to a smaller extent U.S., financial institutions. The failure to pay the debt when it becomes due would result in losses to those financial institutions holding the debt, which in turn could force them to reduce lending activities, dampening economic growth prospects in many countries and ultimately pushing down asset prices (bonds, stocks, real estate). In short, many investors in capital markets across the globe could experience losses in their portfolios.
Greece and Greek investors would most likely suffer the worst of the economic fall-out, much like Argentina did in 2002 when that country defaulted on its debt. The result was unprecedented high levels of unemployment, massive capital flight and a dysfunctional banking system for a couple of years.
Even if Greece does not default on its debt, investors are still likely to incur losses since one component of the EU/IMF rescue plan calls for Greek government bondholders to "voluntarily" accept a 50 percent write-down of their debt. And to make matters worse, the ISDA (International Swaps and Derivatives Association, which sanctions derivative financial products) has deemed the 50 percent haircut "voluntary", which means that any credit default swaps (insurance) covering the debt would not kick in.Whatever the outcome of the current Greek crisis, investors everywhere are likely to be adversely affected.
CFAL is a sister company of The Nassau Guardian under the AF Holdings Ltd. umbrella. CFAL provides investment management, research, brokerage and pension services. For comments, please contact CFAL at: column@cfal.com.
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