If Greece were to default, investors have reasoned, what might prevent the same thing from happening in other countries with large budget deficits?
The circle goes like this, says Mr. Stovall: Greek debt is owned by other banks, such as those in Portugal; Spanish banks own the debt of the Portuguese banks, but German banks own the debt of the Spanish banks – and a lot of US banks own debt issued by German and French banks.
“The reason for all the worry about Greece defaulting is the domino effect,” Stovall says.
Because of those concerns, the US stock market has fallen about 7 percent, dropping for six weeks in a row. Although it finally broke the losing streak last week, there is still a lot of uncertainty among investors, Stovall says.
On Monday, the Dow Jones Industrial Average rose 76.02 points and the Standard & Poor’s 500 index rose 6.86.
“We’re kind of in a wait-and-see mode,” he says. “If the Street really felt Europe would be bailing Greece out anytime soon, I think we would see a larger bounce.”
Most people on Wall Street believe Greece will eventually default, says Stovall. “It’s just a matter of time,” he says.
Even if Greece does fail to pay its creditors, it will not have that much of an impact on US financial institutions, says David Kotok, chief investment officer at Cumberland Advisors in Vineland, N.J. – as long as the “contagion,” as it’s called on Wall Street, does not spread.
“US institutions have some exposure to a Greek default,” says Mr. Kotok. “But we could withstand it.”
Moreover, US money market funds are “insignificantly” exposed to the European lenders that are most at risk of losses on Greek debt, says Jeffrey Kleintop, chief market strategist at LPL Financial in Boston, in an analysis e-mailed on Monday.
In fact, Kotok doubts that the Federal Reserve, which meets on Tuesday and Wednesday, will even mention the problems in Greece when it releases its announcement on the future direction of interest rates. Fed Chairman Ben Bernanke might be asked about it during his press conference on Wednesday, Kotok notes.
Kotok warns Greeks that defaulting on their debt would be a very painful experience, based on the experience of Argentina, which defaulted in 2002. It could result in massive unemployment, dysfunctional banks, and major capital flight, he says.
“They should have enough good sense to avoid it,” he says.
Indeed, some investors are starting to think that the Greeks may not default on their debt – at least in the near-term. In order for Greece to financially survive, Kotok says, Socialist Prime Minister George Papandreou must survive a vote of no-confidence, which is scheduled for Tuesday evening.
“My assumption is the confidence vote will succeed and Papandreou will remain and his power will be established,” Kotok says. “My expectations are that he will win by the narrowest of margins.”
If Papandreou survives, he will then have to push through a budget proposal – for all practical purposes dictated by other European nations – that slashes spending further and reforms the financial system. Those proposals have resulted in riots in the streets.
On Monday, Europe’s finance ministers postponed making another round of short-term loans to Greece until such spending cuts and financial reforms make it through the Greek Parliament.
Once that happens, other European nations would make short-term loans, says Kotok. The aim of the loans is to give Greece breathing room until at least 2014, he says.
At that point, presumably the Greek budget would move into surplus.