The fallout may echo the days following the 2008 implosion of Lehman Brothers Holdings Inc. when credit markets froze and the global economy sank into recession, this time with the prospect that the 17-nation euro zone splinters before reaching its teens. The International Monetary Fund, whose annual meetings start in Washington today, reckons the debt crisis has generated as much as 300 billion euros in credit risk for European banks.

Default Risk
Credit-insurance prices on Greece indicate the chance of default at more than 90 percent. Investors can expect losses on Greek debt of as much as 100 percent, says Mark Schofield, head of interest-rate strategy at Citigroup Inc. in London.

“People, justifiably, think the crisis is what we're living now: cuts in wages, pensions and incomes, fewer prospects for the young,” Greek Finance Minister Evangelos Venizelos told reporters yesterday in Athens. “Unfortunately this isn't the crisis. This is an attempt, a difficult attempt, to protect ourselves and avert a crisis. Because the crisis is Argentina: the complete collapse of the economy, institutions, the social fabric and the productive base of the country.”

Even if Greece receives its next aid payment, due next month, default beckons in December when 5.23 billion euros of bonds mature, said Harvinder Sian, senior interest rate strategist at Royal Bank of Scotland Group Plc.

'Too Late'
“It's too late for Greece,” Howard Davies, a former U.K. central banker and financial regulator, told “Bloomberg Surveillance” with Tom Keene and Ken Prewitt. “The Greek situation is tumbling out of hand and I suspect Greece will not be able to avoid a substantial default.”

The introduction of the euro and global financial connections mean previous Greek defaults in the 19th and 20th century, most recently in 1932, don't provide a decent precedent for a failure to satisfy lenders now.

“Contagion will be violent” as the price of the two-year Greek note tumbles below 30 cents per euro from about 65 cents now, predicts Sian. The European Central Bank would be the first responders through purchases of government debt, he says.

Greek Banks
The country's banks, of which National Bank of Greece SA is the largest, would be the next dominoes. They hold most of the 137 billion euros of Greek government bonds in domestic hands, a third of the total and three times their level of capital and reserves, says JPMorgan Chase. As those bonds are written down and equity wiped out, banks would lose the collateral needed to borrow from the ECB and suffer a rush of withdrawals that likely triggers nationalizations, said Commerzbank AG economist Christoph Balz.

“No banking system in the world would survive such a bank run,” said Frankfurt-based Balz.

A hollowed-out banking sector wouldn't be the only danger to an economy that the IMF says will contract for a fourth year in 2012. The Washington-based lender said this week that Greece will shrink 5 percent this year and 2 percent next year, reversing a forecast of a return to growth in 2012.

Unemployment is set to rise to 16.5 percent this year, and to 18.5 percent next year, the highest in the European Union after Spain and dry kindling for potential social unrest.

Even after saving 14 billion euros in debt repayments, much depends on what deal Greece could strike with its creditors.

Debt Load
To restore market confidence the debt needs to be pared to below 100 percent of gross domestic product, Stephane Deo, chief European economist at UBS AG, said in a July study that noted national default was “invented” in Greece with the Delos Temple episode. At the time, the IMF was projecting the debt to peak at 172 percent next year.

The current debt suggests to him a reduction in the face value of outstanding securities — or haircut — of about 50 percent, which would pare the burden to around 80 percent of GDP, the same as Germany and France. Citigroup's Schofield estimates a writedown of 65 percent to 80 percent, potentially rising as high as 100 percent as the economy slows further.

If default is limited to Greece, the fallout may be contained, say Nomura Securities International Inc. strategists including New York-based Jens Nordvig, whose projections allow for an 80 percent haircut. They estimate euro-area banks would lose just over 63 billion euros, with German and French institutions losing 9 billion euros and 16 billion euros respectively. The ECB would face about 75 billion euros in losses on Greek debt it has bought or received as collateral, they say.

'Large Haircuts'
Such amounts suggest “the losses from Greece-related exposures in isolation look manageable, even in a disorderly default scenario with large haircuts,” though the ECB would probably require fresh capital from euro-area governments, Nordvig and colleagues said in a Sept. 7 report.

A debt exchange that was part of the second Greek bailout approved by European leaders in July would impose losses of as little as 5 percent on bondholders, according to a Sept. 7 report by Barclays Capital analysts.

The risk is that the rot spreads beyond Greece as investors begin dumping the debt of other cash-strapped European nations, said Ted Scott, director of global strategy at F&C Asset Management in London. Portugal and Ireland have already been bailed out, while speculators have also tested Italy and Spain. Italy, the world's eighth-largest economy, has a debt of almost 1.6 trillion euros, while Spain, the 12th biggest economy, owes 656 billion euros.

'Grand Solution'
Those possible ripple effects explain why policy makers won't let Greece default, said Charles Diebel, head of market strategy at Lloyds Bank Corporate Markets in London. He expects them to strike a “grand solution” in which richer euro countries such as Germany support the weak and begin issuing joint bonds.

Policy makers “would only allow a Greek default if they think they can contain the fallout, which is a dangerous presumption,” said Diebel.

If Greece, Ireland, Portugal and Spain all impose haircuts, European banks could lose as much as $543 billion with those in Germany and France suffering the most, according to a May report by strategists at Bank of America Merrill Lynch.

Even those figures don't tell the full story because they omit indirect exposure via derivatives such as credit-default swaps. Economists at Fathom Financial Consulting in London calculated in June that U.K. and U.S. banks hold such insurance on Greek debt totaling 25 billion euros and 3.7 billion euros respectively. Extend that metric to the whole European periphery and U.S. banks have a 193 billion euro exposure.

'Even Worse'
Such linkages threaten an “even worse crisis” than the folding of Lehman Brothers, said Scott. “The amount of outstanding debt is more than with Lehman and we don't know the amount of derivative exposure.”

To support the financial system and stave off an economic slump, Carl Weinberg, founder of High Frequency Economics Ltd. in Valhalla, New York, says governments must create a fund to inject capital into banks as the U.S. did with its $700 billion Troubled Asset Relief Program.

“If banks fail, or if they fear big losses, they will stop lending,” said Weinberg. “As things stand today, a credit crunch will corset euroland and a depression will ensue when Greece fails and takes out euroland's banking system.”

BofA-Merrill Lynch economist Laurence Boone calculates a disorderly Greek default with spillover into Spain and Italy could mean the euro-area contracts 1.3 percent in 2012, using the Lehman Brothers episode as a benchmark.

Waiting for Surplus
Her “high probability” scenario of a Greek restructuring in 2013 when Europe's permanent crisis resolution mechanism is operational and Greece is closer to having its primary budget in balance suggests growth of 1 percent next year. The “increasingly likely” option of an orderly restructuring at the end of this year would mean expansion of 0.1 percent, she projects.

Hanging over the debate is also whether Greece could default and remain a member of the euro area. Nouriel Roubini, co-founder of Roubini Global Economics LLC in New York, proposes that default — and an end to debt repayments and required austerity measures — be twinned with an exit from the euro — an approach rejected by European and Greek policy makers — to restore competitiveness and debt sustainability.

Rebounds
After shrinking 10.9 percent in 2002 following its decision to default and devalue, Argentina's economy grew eight years straight, exceeding 8 percent in every year aside from 2008 and 2009. Russia was growing in double digit just two years after defaulting on $40 billion of local debt in 1998.

In contrast, facing only hard choices, EU officials have taken half-measures in the hope that the situation would somehow turn around, said Rodrigo Olivares-Caminal, senior lecturer in financial law at the University of London.

“What they have done so far is a patchwork approach,” he said. “Now things are much worse. It's becoming more expensive not only in economic terms but also in social terms for Greek citizens because now there will be redundancies, now there will be more taxes there will be less jobs and things will get worse.”

Bloomberg News

Copyright 2018 Bloomberg. All rights reserved. This material may not be published, broadcast, rewritten, or redistributed.