Eurozone faces Lehman-style meltdown

The Greek debt crisis is "threatening to overwhelm" the eurozone, said Sean O'Grady in The Independent. Last week, after another upward revision to Greece's deficit, along with Greece's formal request for €45bn aid from the EU and the IMF, Greek bond yields soared. They rocketed further this week as ratings agency Standard & Poor's downgraded Greek debt to junk status. Greek ten-year yields have hit 10%; two-year yields have gone beyond 16%. An S&P downgrade for Portugal caused a 0.5% spike in its ten-year yield. It also boosted the interest rates on the debt of other economies that are vulnerable to a debt crisis.

What the commentators said

A key reason markets are so rattled is Europe's "paralysis" in tackling Greece's debt problem, said Landon Thomas in The New York Times. The package, first mooted months ago, still isn't a done deal. German Chancellor Angela Merkel is negotiating a minefield as a key local election looms.

She is hoping to placate an electorate strongly opposed to bailing out a profligate eurozone member that cooked the books by demanding a longer-term package of austerity measures. Opposition in parliament is also strong. Some other countries also have yet officially to approve the measure. "This is a hell of a way to run a bail-out," said Alan Beattie in the FT. It's "an exercise in cat-herding".

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The loan is not only "overdue", but "insufficient", as Lex pointed out in the FT. Barclays Capital reckons Greece will need at least e90bn to get the "breathing space to implement a credible fiscal adjustment". Credible is the operative word here: there are "growing doubts as to whether Greece has the stomach to reduce its debts to a sustainable level without defaulting or rescheduling", said Capital Economics.

So fear of default, and hence high yields, will endure even after a bail-out. Default could have "calamitous effects on the fragile European banking system", said The Economist. European banks have around €120bn of overall exposure to Greece, most of which is sovereign debt. And the outlook for banks would be far worse if contagion pushed Spain and Portugal into a

debt crisis.

Socit Gnrale estimates that Europe has lent a sum worth 19% of its GDP to the most vulnerable peripheral countries. Yet contagion is all too possible. Spain and Portugal "are dependent on the kindness of strangers", said Jonathan Tepper of Variant Perception. They have to refinance large chunks of debt €225bn in Spain's case this year in international markets.

But investors worried about a rout akin to that in Greek debt could demand ever higher rates for new debt, or dump the debt they already have. That would send interest rates on the debt pile soaring and hasten default, threatening a cascade of defaults across the financial system. No wonder, said O'Grady, that many analysts fear a Lehman-style meltdown.