With markets and political analysts beginning to say that a Greek default is unavoidable, continuing to delay the inevitable may be the best bet to avoid contagion into other Southern European countries, according to some market observers.
Some analysts in the market have been warning of a 'Lehman-style' event, where contagion from Greece spills over into other world markets, shattering confidence and creating another financial crisis.
"Greece certainly has the potential to become the sovereign Lehmans," Julian Jessop, an economist at Capital Economics, wrote in a research note on Tuesday. Uncertainty over the ripple effects throughout the financial system, the crystallisation of concerns about public finances elsewhere, the pressure on weaker members of the euro zone and the undermining of the stability of the monetary union all suggest that the markets "may be too sanguine" in assuming that they can ride out a default, Jessop wrote.
The bankruptcy of US investment bank Lehman Brothers in 2008 was a defining moment in the financial and economic crisis. The bank's losses from the collapsing subprime mortgage crisis and the failure of a number of rescue bids saw it enter liquidation on September 15.
But the turmoil was just beginning, as the secondary effects spread across the financial markets. Confidence was undermined almost fatally, hedge funds and asset managers who used Lehman's prime brokerage arm were suddenly unable to trade.
Companies who had thought securities backed by a Wall Street giant representing low-risk investments suddenly found themselves exposed to a major corporate collapse.
A key difference with the Greek crisis is that it has been so slow and drawn out that it seems unlikely that anyone will be caught by surprise.
In any scenario, the most likely vector of contagion will be the banks. German banks are the largest private holders of Greek government debt, with $22.7 billion, with French banks holding close to $15 billion, according to data from the Bank for International Settlements released earlier this month.
However, analysts say that outside of Greece, those banks should be well capitalized enough to be able to withstand the shock. Again, this is principally because they have been preparing themselves for the worst for some time.
Risk of Political Contagion
Those Greek banks could themselves drive contagion in Central and Eastern Europe (CEE), a research note from Deutsche Bank on Friday warned. Bulgaria currently has the largest exposure in CEE to the Greek financial system, the note said. However, these countries are hardly systemic to the euro zone.
The risk of political contagion – pressure on other governments facing periods of enforced austerity mounting – remains, as does the concern that the dampened sentiment weighing so heavily on other sovereign issuers that they find themselves in new liquidity crises.
As Stephane Deo, European Economist told CNBC.com, "Spain has re-correlated with Greece, which is very worrying".
Spanish yields have risen on uncertainty over the stability of the Greek government and delays to a 12 billion euro tranche of the International Monetary Fund / European Union loan to the country.
However, when Spain issued three billion euros in short-term debt on Tuesday morning there appeared to be significant cover. Yields were high on the three month and six month T-bills, but coverage appeared to be around five times the amount sold, indicating that there is still some confidence in the market.
This applies more broadly to markets, Ryan Hughes, portfolio manager at Skandia Investment Management, told CNBC.com.
"It is all about confidence. If confidence had completely disappeared then markets would have come down a lot more than they have. They're falling, but they're not absolutely collapsing… there is still an element of confidence," Hughes said.
When it comes to political contagion, the Irish and Portuguese governments do not suffer from the crippling lack of market credibility that George Papandreou's Greek government does, Hughes added.
"The Greek government are in an incredibly weak position, and because people in the market haven't got any confidence that they're actually going to deliver what they say… What you've seen in Portugal and Ireland is governments that have been elected, governments that have said they're going to do this, and generally people believe them," he said.
"If there's potential for contagion into Spain, it will be much more an issue of confidence in a Spanish government being able to deliver the kind of reform and savings needed, rather than around particular institutions," Hughes explained.
Waiting for the Stress Tests
Spain's savings banks, or cajas, have been a source of concern for some in the market, who believe them to be under-capitalized. There has been a worry that the EU's banking stress tests may show up the sector's need for recapitalization, which could put a strain on already tight public finances.
Coupled with a liquidity shortage following any default by Greece, this could turn into a crisis, analysts said.
The steady drumbeat of negative news emerging from Greece is leading the markets towards the conclusion that debt re-profiling – changing the terms of the debt repayment to make it easier for the government to pay back - is inevitable.
Ratings agencies have made it clear that they consider any haircut – voluntary or otherwise – as a technical default. On Tuesday Fitch said even a voluntary rollover of maturities on Greek bonds – a solution being floated by euro zone officials as one way to avoid a "credit event" – would be considered a default.
Once again, if Greece and its partners can delay any restructuring until after the results of the stress tests – scheduled to be released some time next month - and until Spain and other countries can be vaccinated by properly capitalizing their banks, then contagion should be contained, analysts told CNBC.com.
"My sense is that a default is unavoidable, the question is when and how you do it. I don't think anyone disagrees with that. So I think the market will be expecting it, preparing for it. The question is, how can you give a bit more time to the market?" UBS' Stephane Deo said.
This puts further pressure on the EU and IMF to continue with their lending program and on the Greek government to ensure that its austerity plan passes through parliament before it runs out of money. A failure to do so, or a terminal collapse of the government, would likely lead to a chaotic default, where the risks of contagion would be much higher, analysts said.
"If you go to an immediate default, the key thing for Europe will be to try to keep Greece ring-fenced. Whether they will be successful or not, I don't know," Deo said. "If it's a disorderly default, with Greece walking away from the negotiations, it could very quickly become quite difficult to manage."