G20 - Preparing For Greek Default

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    Fears Over 'Shockwave' Of Greek Debt Crisis
    9 Comments7:48pm UK, Saturday September 24, 2011

    Ed Conway, economics editor, in Washington DC

    No longer a question of if, but when - that is the tone of discussions over Greece which has dominated the summit of finance ministers in Washington over the weekend.

    Greece is, in terms of its debt, increasingly seen as a lost cause

    According to senior G20 sources, the assumption now is that the country will have to default on its debt by as much as 50% – on top of the 20% voluntary restructuring already agreed in July.

    And so whereas efforts some months ago were aimed at preventing Greece defaulting, the Eurozone, and its G20 colleagues from the world's biggest economies, are instead making secret plans to build a firewall protecting European economies such as Spain and Italy from the prospect of a buyers' strike.

    :: Osborne: Global Debt Crisis Is In 'Dangerous Phase'

    Here's what ministers are currently thinking: Greece is, in sovereign debt terms at least, a lost cause.

    Portugal and Ireland may be salvageable – unlike Greece their austerity plans and bail-outs are yielding at least some results, albeit at the cost of some severe pain.

    A collapse in confidence in the debt of Italy or Spain would be disastrous and unaffordable.

    Greece's austerity cuts have sparked riots - and its financial difficulties look set to send a shockwave across Europe

    A Greek default would send an instant financial shockwave through the euro area, since so many banks – particularly in France and Germany – hold its debt.

    Nonetheless, the first priority ministers have already openly agreed on is to pump more capital into their banks to ensure their balance sheets are healthy enough to withstand it when those Greek debts suddenly become worth half their previous value.

    The IMF said just this week that European banks are undercapitalised to the extent of 200 billion to 300 billion euros. The assumption is that not all the money can be raised from the beleaguered private sector.

    So it is hoped that the euro members could use cash from the European Financial Stability Facility (EFSF), a bailout facility worth around 440 billion euros - to help shore up these bank balance sheets.

    The focus is shifting to protecting the big European economies, such as Italy's

    But many ministers and economists – including UK Chancellor George Osborne, have warned that this fund is not large enough. Earlier this month, the US Treasury Secretary Tim Geithner urged Eurozone ministers to boost the fund using private sector cash.

    The alternative plan, which is being worked on in Europe and was discussed privately this weekend, is instead to use EFSF cash to guarantee sovereign debt.

    In the event of a default, the first 20% of the losses would be absorbed by the EFSF. This would theoretically make the EFSF five times more powerful.

    At the same time, the European Central Bank would continue to step in and buy up troubled Eurozone debt as necessary to prevent their bonds sliding dangerously.

    The hope is that these extra measures would be enough to prevent further contagion throughout the euro area. Whether markets will be convinced remains to be seen.