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European debt crisis

The bigger fear behind Greece: contagion Add to ...

Why do investors, politicians and central bankers worry about a country as small as Greece?

In one sense, they don't. Greece accounts for less than 3 per cent of the European Union's gross domestic product (GDP). Its disappearance from the map wouldn't matter, though missing Greek islands would narrow the list of holiday options.

In another sense, Greece is a monster worry: Contagion.

If Greece defaults on its debt, or goes through a debt-shredding restructuring exercise, watch out. The first victims would be the European banks that hold Greek debt. They would get clobbered.

According to the Bank for International Settlements (BIS), European and American banks have $1.7-trillion (U.S.) of exposure to Portugal, Ireland, Spain and Greece - the so-called PIGS. They are the four euro zone countries in which the debt crisis is alive and well. Earlier this week, Standard & Poor's downgraded Greece's debt to junk. The ratings agency also whacked the debt rating of Spain, where the unemployment rate is now more than 20 per cent, though the country still retains investment-grade status.

Among the banks, those in Germany and France are the most exposed - between them, they hold more than $900-billion of debt issued by the four countries.

Of that amount, the Greek portion comes to some $75-billion for France and $45-billion for Germany (the data is from Sept. 30, 2009, before the Greek crisis began in earnest, suggesting the exposure to the PIGS might be somewhat less now).

Writedowns on the value of Greek debt would be bad enough. Writedowns on the debt issued by all four countries, should the contagion spread, would be significantly worse. It could easily trigger a second banking crisis. Some of the European banks that hold PIGS' debt had near-death experiences during the credit crisis that began with the collapse of Lehman Bros. in September, 2008. Bailouts and nationalizations saved the weakest ones. A sovereign debt crisis might finish them off, in turn sending shock waves through the global banking industry.

Euro zone finance ministers are meeting on Sunday to work on details of a financial bailout for Greece. It's not clear when a final package will be announced, but with a Greece facing a May 19 deadline to pay back maturing debt, the rescue needs to happen soon. As Europe marks May Day on Saturday, protests against government cutbacks in Greece could be tense.

It appears that keeping the fragile European banking system intact is the main reason behind the bailout being put together, albeit reluctantly, by the European Union, with the International Monetary Fund at its side. While many Germans oppose the idea of backstopping Greece, the country's support is essential. German Chancellor Angela Merkel may not want to funnel taxpayers' money to a country that lived beyond its means and fudged its budget deficit figures, but she has Germany's interests firmly in mind. Altruism isn't behind her stated willingness to send the cheque; protecting her banks is.

How the contagion could spread


Deficit (% of GDP) 13.6

Public debt (% of GDP) 115.1

GDP growth 0.7

Total GDP €237-billion

For the longest time, bond investors snapped up debt issued by Greece and the poorer cousins of the euro zone, happy to have high yields on bonds denominated in one of the world's stronger currencies and convinced there was little risk of a default. But that changed suddenly when European leaders dithered on a bailout, and Greece's debt was downgraded to junk status. A quick rescue might have prevented the stampede to the exits. Now, it will be tough to win investors back without an exorbitant cost.


Deficit (% of GDP) 11.2

Public debt (% of GDP) 53.2

GDP growth 1%

Total GDP €1-trillion

It was inevitable that the panic over Greece's financial plight would spread to other high-debt countries facing a grim economic outlook and sliding bond ratings. Spain has a far larger economy than tiny Greece; but much of its rapid expansion in recent years was tied to a since-exploded housing bubble. Its prospects of an early recovery are slim and its financing costs are rising.


Deficit (% of GDP) 9.4

Public debt (% of GDP) 76.8

GDP growth 1%

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