What Will Happen If Greece Defaults

by Rick Newman

U.S. News & World Report
September 15, 2011

You can be excused for thinking that Greece has already defaulted on its debts, causing panic in financial markets and mayhem in the streets of Europe. That might explain why European stocks are in a meltdown this year, with a lesser rout spreading to U.S. shares.

But the market turmoil of the last few weeks is merely a prelude to a Greek default. In reality, if Greece defaults, it probably won't be for a couple of months, at least. But markets now seem to think that a Greek default is inevitable, and the ramifications will be ugly. "Europe is going to go through a disastrous financial crisis on par with what occurred during 2008 in the United States," David Zervos of investing firm Jefferies wrote to clients recently. "It will be every man for himself in Europe as the problem degenerates." With that kind of outlook, it's no surprise that investors in European stocks—especially banks—are fleeing.

The European debt crisis is undeniably complex and confusing—even to Europeans. The 17 nations that operate on the euro set up a bailout fund well over a year ago that was supposed to handle the financial crises in Greece, Ireland, Portugal, and other troubled states. Obviously it hasn't. Here's a simplified explanation for why: Greece needs more money than first expected, and may not be able to produce the deep spending cuts, tax hikes, and sales of public assets necessary to qualify for bailout money. Economic growth that's worse than forecast is making targets even harder to meet. With Greek citizens irate, the internal pressure to escape from brutal austerity measures may become overwhelming. If Greece caves, then the bailout payments would stop and Greece would run out of money, forcing it to default on billions in debt. Many taxpayers in Germany and other European nations would welcome that, since they're sick of sending money to spendthrift neighbors. But a Greek default would punish many of Europe's biggest banks, since they're the ones holding the debt. If Greece defaults, investors would fear the same thing from Ireland and Portugal and perhaps even from Italy and Spain. That's the meltdown scenario investors fear, and nobody's sure how bad it would get.

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