As Greece Teeters, Fallout for Europe Uncertain

June 4, 2015 Updated: June 4, 2015

FRANKFURT, Germany — Many economists think a Greek departure from the euro would be a disaster indeed. For Greece.

But for the rest of Europe?

Some think a Greek exit, or “Grexit,” would not in fact inflict serious damage on Europe’s economy as it struggles to work past a crisis over too much government and bank debt. Comparing a Greek exit to the collapse of U.S. investment bank Lehman Brothers in 2008, which spread panic and deepened a global financial crisis, are misplaced, they say.

Others aren’t so sure. They think that while short term market turmoil might pass quickly, letting a eurozone member leave could permanently damage the 16-year old currency that’s now shared by 19 countries.

Greece’s new left-wing government is struggling to convince its international creditors, which includes its eurozone partners and the International Monetary Fund, that its reform plans are credible. Agreement is necessary for Greece to get the remaining funds in its bailout fund. Without the release of that 7.2 billion euros ($8.1 billion), Greece faces the prospect of an imminent bankruptcy and a potential exit from the euro.

The Greek government is resisting the tough conditions attached to more bailout loans and on Thursday even requested to have the four payments it has to make to the IMF this month bundled together into one on June 30 — a sign that the country is facing acute financial difficulties.

A failure to pay its debts when they are due does not immediately mean Greece leaves the euro. But it raises the chance of an endgame in which Greece simply runs out of money, introduces restrictions on the flow of capital and gears up a new national currency so it can print money to pay its bills.

Here’s what could be at stake outside Greece:

A Period of Turmoil

The first word of an impending departure would likely roil financial markets, in Europe in particular. Stocks and the euro might fall, while borrowing costs for those eurozone governments with still shaky public finances, such as Italy and Portugal, might rise, at least temporarily.

Economist Holger Schmieding at Berenberg Bank in London predicts a period of “disorientation” while market participants figure out what the impact will be.

Yet Schmieding foresees no serious, long-term damage and dismisses talk of any comparison to Lehman Brothers’ collapse. The risk for Europe, he claims, “is very, very small, virtually zero.”

The key difference between Lehman and Greece centers on the element of surprise, according to Schmieding – Lehman’s collapse was so unexpected that it spread panic across financial markets as investors wondered which bank would go under next.

There’s no element of surprise with Greece, though. Everyone has known that the country, which only accounts for around 2 percent of the eurozone economy, has been in trouble since late 2009. Lenders in other countries have had plenty of time to cut back on loans and investments in Greece, so they have little connection to any of the financial troubles there.

“Everybody knows that everybody’s exposure is virtually minimal,” Schmieding said.

Whether Greece stays or goes, just ending the uncertainty would be a plus, says Schmieding: “The resolution of this, one way or another, would be better than the current stalemate.”

The Big Snooze

So far, markets appear to be with Schmieding. European stocks are off recent highs, but haven’t suffered a serious drop.

On the bond markets, even heavily indebted, slow-growth Italy can borrow at 2.10 percent annual interest – that’s down from over 7 percent in late 2011.

Italy, in fact, borrows more cheaply than the U.S., where 10-year government bonds yield 2.32 percent. Admittedly, European markets have been soothed by a 1.1 trillion-euro ($1.2 trillion) bond purchase program from the ECB, which is trying to raise inflation and get the economy growing faster.

Long-term Damage?

Others warn that letting one country leave a supposedly permanent monetary union would undermine confidence in the euro, long-term. Lenders would have to calculate the risk that a country might someday leave – and be unable to pay them back. They would demand higher interest rates to compensate for the risk – meaning higher borrowing costs and blunting one of the key achievements of the monetary union.

Tools To Use Against Trouble

Optimists point to the eurozone’s new tools to defend itself against the sort of financial crisis that it has struggled to deal with for the past few years. As a result of the Greek crisis, and the ensuing problems faced by the likes of Ireland and Spain, the eurozone has set up a bailout fund that can loan to troubled countries.

The ECB has also offered to purchase government bonds of countries that come under pressure if they agree to reforms – that helps keep a lid on borrowing rates. And the ECB now oversees big banks, a contrast from early supervision by national authorities which were sometimes too slow to address problems.

Not So Sure

For all the talk, no one really knows what will happen if Greece exits the euro.

Jonathan Loynes, chief European economist at Capital Economics, says that the direct economic impact should be “pretty small” given Greece’s economic size.

But he said one can’t rule out an unexpected cross-border spread of market turmoil, for instance, that leads to rising borrowing costs for governments and a drag on their finances. It likely would not rival Lehman, but trouble can’t be ruled out.

U.S. Treasury Secretary Jacob Lew has been warning his European counterparts that the risks of Grexit are unknown, and has urged Greece and its creditors to thrash out a deal.

“The big question is, what are the indirect effects?” Loynes said. “Will there be any kind of domino effect, will there be a contagion effect to other countries or other markets, to borrowing costs, financing costs across the eurozone as a whole?”

“No one can know the answer, because you can’t come to some sort of mathematical conclusion about this.”