Global financial turmoil follows call for Greek debt referendum

McClatchy NewspapersNovember 1, 2011 

WASHINGTON — Global stocks skidded Tuesday after a stunning about-face by Greece on a deal agreed to last week to quell the European Union's debt crisis, as investors and analysts scrambled to understand the impact on the U.S. and global economies.

U.S. stocks plunged as investors fretted that Europe's problems, thought largely resolved, now appear far from settled and threaten a weak U.S. economic recovery. Blue chips on the Dow Jones industrial average traded down more than 300 points for most of the day before closing off 297.05 points to 11, 675.96. The S&P 500 closed down 35.02 points to 1218.28 and the NASDAQ lost 77.45 points to finish at 2606.96.

The spectacular collapse of U.S. investment bank MF Global, and allegations of missing funds and irregularities within it, added to the volatility. The financial giant, which held large amounts of Italian debt, is considered the first significant U.S. victim of Europe's widening debt crisis.

Greek Prime Minister George Papandreou shocked fellow European Union heads of state late Monday by announcing that he'd put to a referendum the debt deal negotiated last week at a marathon EU summit. French Prime Minister Nicolas Sarkozy and German Chancellor Angela Merkel on Tuesday summoned Papandreou to a hastily called meeting Wednesday.

Turmoil looks certain to continue this week.

Papandreou held a Cabinet meeting late into the night and said he'd stick to his plans for a referendum. He also called for a parliamentary confidence vote Friday. Several leaders of Papandreou's Socialist Party, called Pasok, threatened to leave the government in protest over the surprise referendum. If there are enough deserters from his own party, the Greek government could collapse while President Barack Obama and leaders of 19 other industrialized nations meet in France on Thursday and Friday.

This is exactly the sort of turmoil that U.S. government officials had warned was possible if foot-dragging in Europe on resolving its debt crisis continued.

"This underscores how important further elaboration and rapid implementation of all the key elements of Europe's larger plan is," a U.S. government official who's familiar with Europe's efforts said only on the condition of anonymity, in order to speak freely about diplomatically sensitive issues.

Analysts struggled to make sense of what a Greek government collapse, new elections or even a new national unity government might mean, and how long it may take it to play out.

"How do you want me to make long-term predictions?" quipped Nicolas Veron, a senior economist at the European research center Bruegel, when asked what may unfold over the next 48 hours.

Financial-market anxiety is spreading, he warned, and Greece's problems are making things worse in Italy, which is undertaking similar unpopular austerity measures in its government spending and needs to issue large amounts of debt to make payments to creditors.

Some Europe watchers saw Papandreou's action as a shrewd move designed to force his political opposition into openly supporting austerity and the unpopular EU deal as the price of retaining the euro as the country's currency.

"It's an attempt to force the main opposition party into sharing responsibility for the agreement," said Jacob Kirkegaard, a research fellow at the Peterson Institute for International Economics in Washington, and a Danish national. "Everybody knows that a referendum is extremely risky. If it's a 'no,' the reality would be that the (bailout) program would end because Europeans would cut them off."

The legal mechanism for the exit of Greece from the EU is murky. No member ever has left the EU. Greece's departure would raise investor fears of who's next.

If the Greek government collapses or a new one takes over and refuses to honor the debt agreement, the EU would cut off all bailout funding to Greece, Kirkegaard said. The European Central Bank would stop taking Greek financial assets as collateral and Greece would become a financial-pariah nation, untouchable for lenders everywhere.

That in turn would push what's been a protracted downturn in Greece into a possible depression. EU leaders would spend their energy trying to keep Greece's problems from spreading and bringing down other economies. Banks would have to set aside even more money as protective buffers and a credit freeze probably would spread across Europe, as it did during the U.S. financial crisis in 2008.

The European Central Bank, Kirkegaard said, probably would emulate the U.S. Federal Reserve and aggressively purchase bonds from member nations at rates more favorable than market participants would demand. Rating agencies such as Moody's Investors Service and Standard & Poor's could downgrade the credit ratings of Italy, Spain and France, raising borrowing costs for them all and making it hard for these nations to pull out of a downward economic spiral.

"The economic disaster would be nearly instantaneous, but the political process would be probably lengthy and messy. But legally, I believe, it would end with Greece compelled to leave both the European Union and the euro," Kierkegaard said.

The wee-hours deal that European leaders reached last week involved having private-sector holders of Greek bonds agree to take a 50 percent loss — dubbed a haircut — in exchange for taking a new Greek bond that would be backed by the European Union.

The deal — conditioned on Greece continuing to impose bitter austerity measures on government spending — also sought to force European banks to squirrel away more money for emergencies and bolstered a bailout fund designed to keep Greece's problems from contaminating its EU partners.

The Institute of International Finance, the trade association for major global banks, many of which hold Greek bonds, issued a statement Tuesday that said it was sticking to its end of the deal.

"We will work closely with the Greek authorities, euro area officials and other relevant parties to agree on, finalize and move toward implementation of the details of the voluntary Private Sector Involvement (PSI) in support of Greece's reform effort to recover from the current crisis, restore market access and lay the basis for renewed growth," the statement said.

However, an insider who's close to the negotiations with Greece, who insisted on anonymity in order to speak freely, said there was no room for renegotiating the bond-swap terms because last week's deal "set the parameters for a debt exchange offer." Talks continued Tuesday to finalize fine points in last week's deal, such as the maturity date of the new bonds and what rate of return they'd provide investors.

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