The euro zone's €1-trillion nightmare

No one expected the Greek bond swap deal with private-sector creditors to go down smoothly, not when haircuts of more than 70 per cent are being forced down their throats. But it's not as if the holdouts have a serious alternative. There's no more money on the table, and they would do far worse in the open market or in a messy Greek default.

The speculators still hope to cash in on their credit default insurance, as soon as Athens tries to force all private bondholders to accept the same terms. But what if you're an institutional investor also holding, say, Spanish or Italian bonds or securities issued by euro zone banks? The value of many of those investments would fall off a cliff.

The Institute of International Finance, the financial lobby that helped craft the Greek swap deal, calculates that its failure – and the inevitable default that would follow later this month – would trigger more than €1-trillion worth of misery across the euro zone. Talk about an investors' nightmare,

The troubled peripheral countries would be hit hardest, as debt financing costs soared to new heights. The IIF said in a confidential report obtained by Reuters that Ireland and Portugal would need as much as €380-billion in additional bailout money over the next five years and Spain and Italy might need €350-billion "to stem contagion."

But the banking system, corporate bond and equity markets would also take a severe pounding. The IIF estimates additional bank recapitalization costs of €160-billion. And it may be underestimating the fallout.

The European Central Bank, which is not part of the Greek restructuring, stands to lose the most as the largest single holder of Greek debt and with no credit default protection. The IIF puts ECB exposure at €177-billion, more than 200 per cent of its capital base.

Meanwhile, the Greek drama is playing out against a deteriorating economy across the euro area. The new austerity that has become the watchword for the region will only worsen already grim conditions in countries like Italy, where GDP plunged 0.7 per cent in the fourth quarter from the third.

Not a pretty picture, no matter who is holding the paint brush.