Greece crisis: Not Europe's Lehman (it could be worse)

Robert Peston
Economics editor

image copyrightAFP

Eurozone finance ministers' overnight decision to withhold payment of 12bn euros (£10bn) of emergency loans to Greece, pending agreement by the Greek parliament on austerity measures and privatisations, would be rational and credible on the basis that Greece has more to lose from a disorderly Greek default than the eurozone itself.

Or to put it another way, threats are only worth making if those making the threats could actually carry them out.

But if, as is not impossible, the Greek prime minister George Papandreou - under extreme pressure from popular and parliamentary opposition - were unable in the coming few days to win backing for his reshaped cabinet and the deficit reduction programme demanded by Germany, France and the rest, would other eurozone governments sit idly by as Greece told its creditors they couldn't have their money back?

The point is that such an event would have potentially catastrophic consequences for holders not only of 340bn euros (£300bn) of Greek sovereign debt, but also for holders of hundreds of billions of euros of Greek commercial debt and tens of billions of euros of derivative contracts linked to Greek debts.

At a stroke, such a default would also increase the perceived risk of lending to Ireland and Portugal, triggering vast additional losses on hundreds of billions of euros of loans to those states and their respective banks.

And with the jury out about the long term sustainability of Spanish and Italian debts, the governments of those countries would find themselves having to pay a painful bigger premium over what Germany pays to borrow.

In itself, such an event of default would blow up the balance sheets of banks all over Europe: the banks in Greece, Portugal and Ireland itself could survive (probably) only as nationalised entities; and some banks in France, Germany and even the US would suffer losses that would take their capital resources to dangerously low levels.

As for the European Central Bank, as the holder of more Greek, Portuguese and Irish sovereign debt than any other institution on the planet, it too would be bust, requiring a massive injection of financial support from eurozone countries - which would be the kind of public humiliation from which the ECB would take years, in a reputational sense, to recover.

Do the finance ministers of Germany, France, the Netherlands et al really want that?

Nor, of course, would that be the end of the potential catastrophe. As my colleague Chris Morris has been pointing out in compelling and chilling reports from Athens, there is a growing popular movement in Greece for the country to pull out of the euro altogether - with the likes of London's mayor, Boris Johnson, demonstrating in the streets (in a metaphorical sense) with the revolting Greek populace.

Here's the thing. If any eurozone member were to leave the euro, if Greece or anyone else were to adopt its own independent currency, the cost of borrowing for pretty much every other eurozone member - with the exception of Germany, Luxembourg and the Netherlands - would rise.

The reason is that euro membership would no longer be forever. So anyone lending to Spain, Italy or even France would have to be compensated for the risk - however remote - that their euro-denominated debt would one day convert into something tied more directly to the health of their respective economies and the strength of their respective public-sector balance sheets.

In the current fragile state of the eurozone's economic recovery, a rise in borrowing costs for eurozone member states would be profoundly unhelpful.

Oh, and let's not waste time considering the minefield of international litigation that would be created by a unilateral decision by Greece to turn hard euro debts into soft drachma debts - or to dwell on whether the conversion could in practice apply only to government borrowings, or whether it would also extend to government-guaranteed debts or pure commercial debts.

So, putting all this together leads to two inescapable conclusions.

First, that when people talk about Greece as Europe's Lehman moment, they are wrong. Letting Greece default in a disorderly, uncontrolled way would probably be a good deal worse for the global economy than Lehman's collapse - for all that banks in general have more capital to absorb losses than was the case in the autumn of 2008, and are less dangerously inter-connected with each other.

Second, the eurozone ministers' decision to postpone the definitive decision on a further 12bn euros of bridging loans for Greece is not likely to scare Greece's austerity objectors into submission.

It could well persuade the Greek opponents of fiscal retrenchment that eurozone ministers are all talk and no trousers, that they are so disunited on how to fashion a fundamental solution to Greece's excessive debts that Greece is better off taking direct control of its own economic destiny.

However, if this eurozone brinkmanship nudges the Greek parliament to reject the further budget squeeze, we'll be closer than is remotely prudent or sensible to a 1930s-style financial and economic disaster.