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Friday, June 17, 2011
Pundits argue that a Greek default is inevitable. Even former Fed Chairman Alan Greenspan chipped in with his two cents last night, and he is one who should know fairly well what it takes to bring an economy to its knees.
Imagine taking a car loan out for $35,000 and and then losing your job. Your car is worth $25,000, the loan is outstanding, and you have no savings. Your peers tell you to cut back on job search expenses and are tired of lending you money. In fact, you owe your friends so much that they are vulnerable if you don't pay them back. This is the situation that Greece and the European Union is in.
Some say that loans would be a waste of time and money - instead just give Greece the money to solve its problems. But, then again, Greece isn't the only country in difficulty and the question is: where does it end. Unfortunately, these situations seem to have an underlying commonality - those who play by the rules and live within their means are expected to bail out and sacrifice to pay for those who live beyond their means.
Plenty of advice has been offered by the U.S. which, ironically, is traveling down the same road. Its municipalities (not to even mention the Federal Government) have over promised and many find themselves in dire straits.
Excellent background on all of this is offered by an interactive site at the New York Times which provides a neat picture of the European Union and the status of each country. The second slide at the site shows that both Italy and Greece have debt-to-GDP ratios exceeding 100%, but 7 of the other 27 members of the Union have debt loads exceeding 75%.
For investors, risk gets measured by interest rate spreads. In the European Union there are 6 countries, as shown on the 7th slide, whose debt pays more than 2% compared to Germany, the benchmark country. Greece's debt has a spread of 15%. The next riskiest is Ireland at 8.6%!
The big concern in all of this is, of course, the much-feared contagion effect. As Greece move closer to default, a major repricing of risk is taking place. The end result is anybody's guess, but chances are it won't be pretty.