May 10, 2012 at 2:52 PM ET
The deepening political turmoil in Greece has begun reverberating throughout the global financial markets as Athens’ failure to form a government last weekend threatens to further undermine the battered European economy and banking system.
Two years after European leaders began engineering a bailout for the debt-laden Greek government in return for deep spending cuts, the grand plan to cement the widening cracks in Europe’s common currency appears to have collapsed.
There is no Plan B.
"Greece is an unguided missile launched from the middle of the eurozone," said Carl Weinberg, chief economist at High Frequency Economics. “How, when and where it will strike cannot be predicted."
On Thursday, Greece’s fragmented political leadership failed in another last-ditch effort to form a government, all but assuring another round of elections next month. Voters swept from power the two major parties that had engineered a painful austerity plan with Europe’s wealthier countries, led by Germany, in exchange for an ongoing financial lifeline.
With no government in place to enforce spending cuts, the European Union temporarily cut off a portion of that lifeline, raising the likelihood that Greece will be forced to leave the 17-nation compact that shares a common currency. The Athens government is due to run out of cash in June.
Without the financial lifeline or membership in the common currency, Greece faces a grim future. With its economy already contracting at an estimated 6 percent annual rate, an exit from the eurozone would accelerate its economic and financial collapse. But holders of its debt, including Europe’s banking system, would also feel the blow.
The turmoil is already putting pressure on other European governments wrestling with large debts and deep spending cuts.
No one can predict the outcome. And unlike the sudden financial panic that swept the world in September 2008, some analysts say, the crisis could stretch on for years. Europe has become a “slow motion train wreck,” according to New York University economist Nouriel Roubini.
"Slow motion because it might take three or four years," he told CNBC. "But three or four years in which all these risks coming from the eurozone -- economic, political, fiscal, financial -- are going to get gradually worse."
For the moment, Spain appears to be the most vulnerable to the “contagion” of Greece’s apparently imminent demise.
With Spain’s economy mired in the second recession since 2009 and unemployment at 25 percent, the country’s bankers are struggling with rising loan defaults left behind by a U.S.-style housing bust. Spanish banks, unable to unload bloated inventories of repossessed homes, are stuck with nearly a quarter trillion dollars worth of bad debt.
On Wednesday, the Spanish government took over the latest casualty, Bankia, which holds 10 percent of the Spanish banking system's deposits. Government officials there are expected to demand as early as Friday that bankers set aside more capital to offset those debts. That would leave them with less cash to lend to businesses and consumers, dampening spending and deepening the recession.
That recession is spreading across Europe. On Thursday, the OECD said in a monthly economic update that France and Italy are showing further signs of weakness.
That leaves Germany, Europe’s largest economy, as the main provider of financial lifelines to its weaker neighbors. Despite growing signs that deep budget cuts are worsening Europe’s economic contraction, German leaders remain publicly steadfast in support of further “austerity” as the ultimate cure.
On Thursday, German Chancellor Angela Merkel insisted, in a newspaper interview, that Greece has to follow through on further cuts due next month under terms of the bailout negotiated by its government. German Finance Minister Wolfgang Schaeuble said Thursday that Europe and the International Monetary Fund stood ready to help Greece, but the country’s fate would depend on adherence to the existing plan.
"Whether Greece is ready to do what is necessary - only the Greek people can decide," he told a news conference. "Greece can rely on the solidarity of Europe, but if Greece does not help itself, there is nothing to be done."
If the austerity plan fails and Germany withdraws financial support, Greece would almost certainly default on its debt, including loans already extended by the IMF and European Central Bank. The impact of those losses could make it much more difficult for other countries to win support for bailouts of their own.
"If after all this Greece has to be written off after all, it will also add to aid fatigue that is making the round in the countries financing the bailouts," said Natascha Gewaltig, head of European economics for Action Economics.
Borrowers across Europe already face a tougher time getting credit as banks are apparently hoarding cash to weather an increasingly risky and uncertain future, according to a recent analysis by the Wall Street Journal. At the end of March, 10 of Europe's biggest banks had parked nearly $1.2 trillion at central banks around the world. That’s $128 billion, or 12 percent, higher than December and up 66 percent from the end of 2010, the Journal said.
As Europe’s economic and financial crisis drags on, tighter credit conditions could spread worldwide to large companies trying to raise cash by selling bonds. On Thursday, Standard & Poor's issued a report estimating that nonfinancial corporations in the eurozone, U.K., U.S., China, and Japan will need to raise $43 trillion to $46 trillion over the next five years, including $30 trillion of debt to refinance existing bonds and $13 trillion to $16 trillion of new money to fund growth. The report warned of "credit rationing that may occur as banks seek to restructure their balance sheets" and investors grow jittery about the risks of buying all that debt.
"Combined with the eurozone crisis, the slow U.S. economic recovery, and the prospect of a slowing economy in China, this raises the downside risk of a perfect storm in global corporate credit markets," said Jayan Dhru, S&P head of global corporate ratings.
Investors are also warily watching the looming "fiscal cliff" facing the biggest borrower of all, the U.S. government. Unless Congress and the White House can steer away from it, massive tax hikes and spending cuts are scheduled to take effect at year-end. Economists have warned the combined impact could cost the U.S. economy between 2.5 and 5 percent of gross domestic product, stopping the anemic recovery in its tracks.
"The markets are telling Washington, 'You better get it in gear; you cannot let this uncertainty overhang the market,'" said Yra Harris, a currency trader at Praxis Trading. "This uncertainty is really making people nervous."