Traders Seek Out the Next Greece in an Ailing Europe

Is Spain the next Greece? Or Italy? Or Portugal?

Even as Greece pledged anew on Wednesday to rein in its runaway budget deficit, briefly easing the anxiety over its perilous finances, traders on both sides of the Atlantic weighed the risks — and potential rewards — posed by the groaning debts of other European governments.

While investors welcomed news that Athens would raise taxes and cut spending by $6.5 billion this year, analysts warned the moves might not be enough to avert a bailout for Greece or to contain the crisis shaking Europe and its common currency, the euro.

Getty Images Riot police line up outside a closed branch of the National Bank of Greece during a 24-hour general strike.

Indeed, some banks and hedge funds have already begun to turn their attention to other indebted nations, particularly Portugal, Spain, Italy and, to a lesser degree, Ireland.

The role of such traders has become increasingly controversial in Europe and the United States. The Justice Department’s antitrust division is examining whether at least four hedge funds colluded on a bet against the euro last month.

“If the problems of Greece aren’t addressed now, there is a risk the market will focus on the next weakest link in the chain,” said Jim Caron, global head of interest rate strategy at Morgan Stanley.

Whatever the outcome in Athens, the debt crisis in Europe threatens to tip the financial, as well as political, balance of power across the Continent. With Germany and France emerging as the most likely rescuers, leaders in Berlin and Paris could end up dictating fiscal policy in Portugal, Ireland, Italy, Greece and Spain.

And in the months ahead, fears about the growing debt burden elsewhere in Europe are likely to return, according to investors and strategists. That is particularly worrying given that Western European countries must raise more than half a trillion dollars this year to refinance existing debts and cover their widening budget gaps.

The way fear can spread from capital to capital reminds Mr. Caron of how the American financial crisis played out. “What people are doing in the markets is no different from what they did with the banks,” he said. “First it was Bear Stearns, then it was Lehman Brothers and so on. That’s what people are worried about.”

France and Germany are emerging as the crucial backers of any lifeline for Greece, but they have slow growth and budget troubles of their own — deficits equaling 6.3 percent of gross domestic product in Germany and 7.5 percent in France. And among voters in both countries, “there is very little appetite for rescues,” said Marco Annunziata, chief economist for Unicredit.

The most vulnerable country after Greece, some analysts say, is Spain, which has been mired in a deep recession. Facing an unemployment rate of 20 percent, a budget gap of more than 10 percent of gross domestic product, and an economy expected to shrink by 0.4 percent this year, Madrid has little wiggle room if investors shun an expected 85 billion euros in new bond offerings this year.

Spain’s neighbor Portugal is also vulnerable. Large budget and trade deficits, combined with a shortage of domestic savings, leave Portugal dependent on foreign investors. And, as in Greece, there may be little political will to slash spending or raise taxes.

That’s in sharp contrast to Ireland, which had been a source of anxiety last year. New austerity measures, including a government hiring freeze and public sector wage cuts, have put it in a stronger position as it raises 19 billion euros this year.

The Italian government is also heavily indebted — it has more than $2 trillion in total exposure — but it is also in a slightly stronger position than Spain or Portugal because its economy is expected to grow by 0.9 percent this year and 1.0 percent next year. In addition, its budget is not as far out of whack, with the deficit this year expected to equal 5.4 percent of G.D.P.

Angelo Cavalli | Photodisc | Getty Images

According to Kenneth J. Heinz of Hedge Fund Research, the big hedge funds are now evaluating the response by other European countries in extending a lifeline to Greece before they probe weaknesses and opportunities in other countries.

Hedge funds, banks and other institutions are still wagering on a drop in the euro as well as the British pound.

Those trades have been controversial for months in Europe. But the debate shifted to the United States on Wednesday, after it emerged that at least four hedge funds had been asked by the Justice Department to turn over trading records and other documents. That request followed a dinner in New York last month where, among several other subjects, representatives of some of these hedge funds discussed betting against the euro.

The funds that received the letters — Greenlight Capital, SAC Capitol Advisors, Paulson & Company and Soros Fund Management — are among the best-known names in the hedge fund universe. Greenlight and SAC declined to comment, as did the Justice Department. Paulson & Company, whose representatives did not attend the dinner, also declined to comment.

In a statement, Michael Vachon, a spokesman for Soros Fund Management, denied any wrongdoing and said, “It has become commonplace to direct attention toward George Soros whenever currency markets are in the news.”

The dinner, in a private room at the Park Avenue Townhouse restaurant in Manhattan on Feb. 2, involved about 20 people and was characterized as an “ideas round table” by several who attended. But people present at the dinner or knowledgeable about the discussion said the idea of shorting the euro occupied only a few minutes of the conversation.

The presentation on the euro, by SAC, lasted less than five minutes, according to these people.

Notes provided by one of the firms that attended the dinner summarized the discussion on the euro state: “Greece is important but not that important; instead you have to start thinking about every other country. What’s after Greece? Spain, Ireland, Portugal.”

James S. Chanos, a hedge fund investor who has not been making bets on the euro, defended the positions taken by hedge funds, calling the inquiries into their activities “witch hunts.”

“Hedge funds and short-sellers are being blamed for the failings of other people,” he said. Nevertheless, the anxiety in Europe is reflected on the Chicago Mercantile Exchange, where trading in futures on the euro soared to a record $60 billion in February — up 71 percent from a year ago.

“The Greek story is putting downward pressure on the euro,” said Derek Sammann, a managing director at the CME. According to CME data, hedge funds are in their most bearish position in a decade in shorting the euro, said Mary Ann Bartels of Bank of America Merrill Lynch.

“They have been short for a while, but in the past two weeks have really pressed it,” she said.

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