Ben Chu: Greek default could have same impact as Lehman collapse

Analysis

Why does Greece's debt crisis matter to the rest of us? The answer, in a word: contagion.

If Greece defaults or crashes out of the euro it will send an almighty shockwave through the global capital markets. First of all, French and German banks, which are estimated to hold up to 70 per cent of Greece's debt, will register writedowns. If their exposure is great enough, they could even go bust.

The fear that commercial banks were on the verge of failure was responsible for the last credit crunch as financial firms grew wary of lending money to each other at anything other than penal interest rates. If that fear of failure returns, we might witness another savage contraction in lending. And another credit crunch would open the way for the long-feared "double dip" recession.

But an even greater economic danger could lie in the effect that a Greek default would have on investors' perception of the credit risk of holding sovereign eurozone bonds, which for much of the past decade they have treated as equally safe investments. The interest rate on Spanish, Portuguese and Irish bonds has been creeping up in recent days as investors have begun to wonder who might follow Greece down the road to default.

Yesterday's downgrading of Spain's sovereign debt by a notch to AA status by the credit rating agency Standard and Poor's was an ominous sign. If investors in Greek bonds end up losing money, those rates are likely to shoot up still further. Spain, Portugal and Ireland could yet find themselves in their own Greek-style debt tragedy. And while European banks stand to make losses on Greek debt, they are even more exposed to the debts of the rest of the so-called "PIGS".

The clean-up bill would be vast. One analyst has estimated that Greece could need £90bn, Portugal £40bn and Spain £350bn in loan guarantees if the worst came to the worst. It is unclear whether the eurozone could afford a bailout on such a scale, even if the economically stronger nations of the zone, primarily Germany, were prepared to sanction it.

This makes the case for early action. A Greek default could have the same effect on global financial and economic confidence as the 2008 bankruptcy of Lehman Brothers. If policymakers in Berlin think that the costs of bailing Athens out are high, they should consider the potential costs of letting it go under.