The Greek Dominos: What Happens If Greece Defaults?

Photo: Aris Messinis | AFP | Getty Images If Greece defaults on its sovereign debt, the effects will be global.Everyone from Japanese savers to U.S. retirees is likely to feel the effects. Let's run through the dominos that could fall after a Greek default. By John CarneyPosted 16 June 2011

Photo: Louisa Gouliamaki | AFP | Getty Images The banks of Greece are heavily exposed to the sovereign debt of their country. A default would require many of them to seek new capital to make up for the losses, and could trigger a run on banks by Greek depositors. It's very likely that the Greek government would be forced to declare a "bank holiday" to prevent a run. Eventually, the most exposed Greek banks would likely have to be nationalized.

Photo: Fabrice Coffrini | AFP | Getty Images Europe's banks are big holders of Greek debt. They have something like $53 billion outstanding. France, Germany and the U.K. are the most exposed. "If bondholders were required to take a 40 percent 'haircut'—a figure thrown up by many analysts—this would translate to losses in the order of €15.6 billion," or $22 billion, according to one report.

Photo: Getty Images It's unknown what the exposure of various financial institutions to a Greek default through credit default swaps might be. But someone has been selling lots of protection on Greek debt over the last few years, and a default would trigger a "credit event" payout on these insurance contracts.

Photo: Getty Images Doubts about the stability of financial institutions with direct and indirect exposure to Greece are likely to spread. Banks may hesitate to extend credit to each other out of fear about exposures. Many will require counter-parties to hand over additional collateral, forcing assets sales. In a repeat of the aftermath of the bankruptcy of Lehman Brothers, global credit markets may seize up. Get ready to hear lots of talk about LIBOR spreads again.

Photo: Getty Images Analysts say that U.S. money-market funds have more exposure to the short-term debt of European banks than many investors realize. If European banks cannot roll over their commercial paper, some of these money-market funds may find they have capital shortfalls.

Photo: Carl De Souza | AFP | Getty Images The Irish and the Portuguese are facing years of slow economic growth as their governments attempts to bring down debt levels and stabilize their banking systems. A default by Greece—especially if brought about by a popular uprising in the streets of Athens—could encourage these countries to default. If Greece can force creditors to take a haircut, why should Ireland and Portugal pay in full?

Photo: Getty Images The European Central Bank is massively exposed not only to Greek sovereign debt but to the debt of Irish banks. If Greece and Ireland's banks do not make good on their debts, the ECB could be rendered insolvent, according to some analysts. Of course, the ECB is a central bank—which means it can always inflate its way back into solvency.

Photo: Getty Images The turmoil across Europe may shake the government in Germany. The German people strongly oppose bailouts of what they view as less responsible countries. Any moves by the German government to alleviate the crisis caused by Greece could be met with a political revolt in the already shaky government of Angela Merkel.

Photo: iStock Consumer confidence is already at a near nadir. A global credit crisis would likely convince U.S. consumers to reduce spending and increase savings. This could drag the already slowing American economy nearer to a recession.

Photo: Getty Images One thing is certain: Political leaders around the globe will attempt to reassure their constituents and prevent financial panics. The appearance of politicians paraphrasing Franklin D. Roosevelt's "the only thing we have to fear is fear itself" line is unlikely to make any difference whatsoever.

Photo: Getty Images Rob Subbaraman, an economist at Nomura, has warned that if Germany and France are burdened with the debts of southern Europe, “it is conceivable that to support these economies, a new form of protectionism takes house, whereby countries such as France and Germany buy more goods from them at the expense of Asian exports.”

Photo: Keren Su | Getty Images If U.S. consumers retreat and Europe goes protectionist, the weaknesses in the Chinese economy may become more evident. A slowdown in demand for goods from China could force the government to abandon its fight against inflation in order to keep the economy growing.The alternative could be a "hard landing" scenario for China, in which years of over-investment in housing and infrastructure are revealed to be costly mistakes.

Photo: iStock Following the chaos likely to result from a default by Greece, it's unlikely that U.S. politicians will be willing to tempt fate by pushing for political gains in connection with the debt ceiling of the U.S. government. Politicians will quickly fall in line and support raising the debt ceiling.

Photo: Getty Images This parade of horribles does not portend the end of the world. The sun will rise the day in the event Greece defaults. And it will rise the next day, and the next. People will still fall in love, get married, have children, make friends, and find innovative ways to cope with a world that seems a little less safe than it did a few months ago.Eventually, someone, somewhere, will make a fortune by correctly calling the inevitable economic recovery.

© 2012 CNBC.com