As the Greek government teeters and European countries appear deadlocked over a rescue plan, holders of Greek debt face the biggest immediate risk. But the question many investors are asking — just as they did when the collapse of Lehman Bros. sparked the Panic of 2008 — is who, exactly, holds that debt?
“This fear of Greek contagion breeds not only a credit crisis but a liquidity crisis, not only in Europe,” said Lincoln Ellis, a managing director at the investment firm Linn Group. “It could spread to the American banking sector as well.”
Much of Greece’s shaky debt is held on the books of large European banks, which would take the brunt of the impact of a possible default. With the odds of that increasing, bond rating agency Moody’s investor Service on Thursday threatened to downgrade credit ratings for three major French banks: BNP Paribas, Credit Agricole and Societe Generale over their exposure to Greek debt.
The banks have said that any default by Greece would be manageable. But in a world where markets are so interconnected, financial risk flows down the same river of capital. Those French banks, for example, raise a sizeable chunk of money by selling debt to the ten largest U.S. money market funds.
As U.S. banks have expanded to compete on a global playing field, they've increased their exposure the financial stresses on European lenders. Just as the Panic of 2008 was sparked by a relatively small pool of subprime mortgages, a default by Greece could spark wider defaults by subprime government borrowers like Portugal, Spain and Ireland.
U.S. bankers could also be at risk if they've lent too much money to investors placing big bets, so-called credit default swaps, that are supposed to pay off if Greece defaults on its bonds. But, much like the lead-up to the Panic of 2008, it’s not well-known just who is holding the losing side of those bets.
The risk to the banking system is that a concentration of bad bets overwhlems one of the nodes in the global financial network, short-circuiting the credit markets and forcing up the cost of borrowing. Much the same thing happened in 2008, when insurance giant AIG was inundated with a flood of redemptions for credit default swaps on mortgage debt that forced the Federal Reserve to have to help bail the company out.
Click to expand...