Q&A: What happens if Greece defaults on its debts? By ALEX BRUMMER Last updated at 9:15 AM on 26th September 2011
Comments (4) Share City editor Alex Brummer explains Greece's debt and how its missed payment could affect the rest of Europe.
Why is Greece in so much trouble, given it has received £97billion in bailouts?
For the last decade the country has lived beyond its means. Despite promising to rein in spending and sell off the family silver, the markets have all but given up hope Greece will ever pay off its debts in full and they expect the country to default. Greece has a colossal £305billion of debts – equivalent to more than 160 per cent of its annual economic output.
What does a default mean?
A country in default effectively admits it is bankrupt and can no longer meet either the interest or the capital repayments on its debt. The talk at the IMF in Washington over the weekend is that the face value of the debt will have to be cut by at least 50 per cent. This means an investor holding Greek bonds with a face value of 10,000 euros would only get back 5,000. The value of the Greek debt has already been plummeting, which is why the French and other European banks, which own a very large number of these IOUs, are now under the spotlight.
New bailout fund: This will be combined with the resources of the European Central Bank to produce a fighting fund of trillions of euros
How big a crisis would a default be for French banks?
It is a potential disaster. French lenders have a gigantic £36billion exposure to Greece, according to the Swiss-based Bank for International Settlements. The shadow of debt hanging over French banks is forcing them to sell assets to raise capital. In the event of a Greek default, the French may have to inject new funds into the banks and part-nationalise them to prevent their collapse. In a sign of the mounting crisis, French authorities have denied speculation such plans are being drawn up. If the debt contagion were to spread beyond France, things could get far worse. The total exposure of European banks to all ClubMed nations – Greece, Spain, Portugal and Italy – is estimated at a terrifying £1.3trillion.
Can anything be done to prevent a calamity?
European finance officials are under pressure to put a safety net under the euro by the time of the Cannes G20 summit in early November. Officials are introducing speedy legislation across the eurozone to implement a new bailout fund known as the European Financial Stability Facility. This will be combined with the resources of the European Central Bank to produce a fighting fund of trillions of euros. The fund has been designed to provide money to countries in difficulty as well as to rescue and re-capitalise banks, as happened in Britain and the U.S. in 2008 when Lehman Brothers collapsed.
More... MONDAY VIEW by ALEX BRUMMER: Greek default is inevitable, it's time to act Osborne denies behind-the-scenes plans are afoot to allow Greece to go bust Small investors lost £34bn on stock market as FTSE 100 slumps by a fifth since start of summer What happens if Germany torpedoes this plan?
It could create a market shock as serious as the collapse of Lehman Brothers. The European Central Bank, which has been propping up the Greek banking system for almost two years, would be required to call back loans it has made to Greece as the collateral provided, in the shape of Greek bonds, would be worthless. This would cause a cascading series of collapses through the Greek financial system and the contagion would spread across the whole euro area and beyond.
How does the crisis affect us?
Fortunately we are not going to be part of any new bailout facility. However, our banks do hold Greek debt and the state-controlled Royal Bank of Scotland has already written down its own Greek debt value by 50 per cent, at a cost of £733million. The prospect of further write-downs has sent UK bank shares tumbling although experts believe British banks have a sufficient capital cushion. But the crisis has sapped global confidence, damaging world recovery. As up to 80 per cent of UK exports go to Europe our manufacturing recovery has stalled and the economy has ground to a halt.
FMG Price at posting:
$4.25 Sentiment: ST Buy Disclosure: Held
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