Escalating Greek Crisis Threatening Global Financial System

The crisis in Greece is getting serious.  It began as a problem with the fiscal credibility of one euro-zone state, but has exposed political and financial fault lines running through the entire European Union.  Politicians are becoming increasingly divided on either side of the Greece/Germany debate, increasing the risks that Greece becomes a big problem for the global financial system.

The seriousness of the crisis is somewhat reflected in Greek bond yields — which rose recently to close to 6.5%, for 10 year-maturities.  German Bunds are now at 3.06% -  their lowest yield in around a year and close to the low of 2.9% hit in the depths of the financial crisis.  This reflects 3 separate forces at work: a flight-to-German safety trade, a preference for German fiscal prudence and fears over the possible spill-over damage the Greek crisis could inflict on the euro-zone economy and financial system.

Another sign of the escalation of concern is the response of European Central Bank (ECB) President Jean-Claude Trichet, who has softened the ECB's hard line on Greece and switched to playing diplomat.  He said Greece could receive loans from other governments if the euro-zone was threatened.

He further suggested the ECB might yet reconsider its collateral rules to allow Greek government debt to remain eligible beyond the end of this year if further ratings downgrades occur. 

Dennis Lockhart, president of the Federal Reserve Bank of Atlanta, warned that the Greek crisis could affect the U.S. economy, resulting from a broad shock to financial markets that could impact the banking system or lead investors to retreat from sovereign debt.

The Greek economy is in shambles and rapidly deteriorating.   Greek unemployment vaulted to an 8-year high of 10.3% in the fourth quarter, up sharply from a 9.3% rate in the third, the National Statistics Service said Thursday.

The data showed unemployment rose across all age groups, impacting young workers between the ages of 15 and 29, who have the highest joblessness with a rate of 20.4% in the fourth quarter, up from 18.5% in the third.  Unemployment for 30 to 44-year olds rose to 9.3% from 8.3%, while for the 45 to 64-year-old age group, joblessness rose to 6.3% from 5.7%.

Germany's potential role in the escalating Greek crisis has led to consternation domestically.  Originally, it appeared that Germany would offer some sort of "bail out" program.  However, in discusssions among euro-zone members, the German government has been thwarted by its concern that plans to help Greece would violate a “no bail-out” clause in EU rules on the euro and expose it to legal challenges before Germany’s highest court, officials said.

Instead, Germany is leaning towards involving the International Monetary Fund should Greece call for help to stem its budget crisis, a move Berlin hopes would help avoid potential constitutional court objections to a German bail-out.

The situation remains fluid in any event and one that has "game-changing" potential.  The longer the situation festers, the greater the threat to the U.S. and world financial system. 

Marko's Take

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