The Greek government is in a gigantic financial hole and is teetering on the brink of defaulting on its debt. It has been able to limp along since last year only with bailouts from outside of Greece.
According to the latest reports, the Greek government will run out of money in October unless it receives the 8 billion euros it is scheduled to receive from the European Commission, European Central Bank, and International Monetary Fund. That money may not be forthcoming. These three institutions, as well as a growing share of European voters, are growing tired of subsidizing what they perceive as the Greek government’s ongoing wastefulness and overspending. They may decide to cut their losses and stop funneling money to what many regard as a hopeless cause.
The situation is volatile. Interest rates on Greek government debt actually fell last week on the hope that Germany, China, the United States, the International Monetary Fund, and the rest of the international cavalry were riding to Greece's rescue.
That hope, however, was only a glimmer. One-year rates fell from an impossible 145 percent to a still-absurd 108 percent. Two-year rates fell, too, but are still over 50 percent. The market price of credit-default swaps now indicates a 98 percent probability of default. The odds of putting the Humpty Dumpty of Greek solvency back together again are slim. The Greek government remains on life-support that may be withdrawn at any time.
A Greek default could plunge Greece into political, social, and economic chaos. The effects, however, would extend far beyond Greece. According to Josef Ackermann, CEO of Deutsche Bank, "It is an open secret that numerous European banks would not survive having to revalue sovereign debt held on the banking book at market levels." A chain reaction of bank failures would cause European credit markets to seize up and economic activity to plunge.
The United States is at risk, too. U.S. banks have almost the same overall exposure to Greek debt as do German banks, the difference being that the Germans' exposure is largely direct, while the United States' is largely indirect, in the form of derivatives such as credit-default swaps (i.e., insurance policies on repayment of Greek debt that U.S. banks have sold).