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How Greece's debt crisis affects U.S. investors and consumers

The biggest threat would be a drying up of credit worldwide if Greece defaulted on its debt. As banks and other lenders are hit with losses, they could drastically rein in lending activity.

July 02, 2011|By Walter Hamilton, Los Angeles Times
  • Demonstrators clash with riot police in front of the Greek Parliament in Athens on June 29 as lawmakers moved toward a vote on a massive austerity package demanded by international creditors.
Demonstrators clash with riot police in front of the Greek Parliament in… (Louisa Gouliamaki, AFP/Getty…)

The prospect of a resolution to the Greek debt crisis, bolstered by Greek lawmakers' approval of a sweeping austerity plan, has buoyed investor spirits: After falling for much of the last two months, in part out of concern about Europe's debt troubles, the stock market rallied each day last week, with the Dow Jones industrial average jumping 5.4% to close within 228 points of its late April high.

Still, important issues need to be resolved for the Greek aid package to go forward. And fear remains that the underlying problems afflicting Greece and some of its European counterparts are being swept under the rug. That means the countries eventually could have to restructure their debts, and bondholders could be forced to accept some losses.

Here's a look at Greece's travails and the potential effects on U.S. investors and consumers:

What's going on in Greece?

Facing a bruising recession and a bloated and inefficient economy, Greece is having trouble paying off the heavy "sovereign" debt it owes to international bondholders.

The European Union, the International Monetary Fund and the European Central Bank have required the country to implement a painful austerity plan as a condition of receiving a potential $17-billion rescue package, the second such bailout for Greece. The proposed budget cuts and tax increases have touched off rioting in Athens by citizens who say the effects on them would be too draconian.

What would happen if Greece defaulted?

The biggest threat would be a drying up of credit worldwide. As banks and other lenders are hit with losses, they could drastically rein in lending activity, thus throwing a monkey wrench into the global economy.

Although Greece represents just a sliver of the overall European economy, economists worry about the threat of "contagion" spreading to other troubled economies, such as Ireland, Portugal and possibly Spain, all of which are stricken with anemic or nonexistent growth and heavy debt.

"Contagion is the real issue, not Greece per se," said Gary Schlossberg, senior economist at Wells Capital Management.

How would U.S. investors be affected?

In addition to a likely hit to the stock market, a tourniquet applied to the global credit markets could crimp the already listless U.S. economy.

Beyond that, a default theoretically could cause losses at normally super-safe money-market mutual funds.

U.S. banks have limited exposure to Greece, but some European banks have large holdings of the country's debt. And some money funds have invested heavily in those banks. The 10 largest U.S. "prime" money funds have about half their assets stowed in European banks, according to a report from Fitch Ratings.

Some money funds could suffer losses if European banks defaulted on their short-term debt. That would be reminiscent of the 2008 financial collapse, when one large fund lost money because of excessive holdings of bankrupt Lehman Bros. Holdings Inc.

Some experts, though, say the concerns about money funds are overblown. Most likely, they say, is that Greece will be able to push its day of reckoning into the future, giving money funds time to lighten their exposure to European banks. They point out that the Lehman-stricken fund lost only a penny a share.

"Even a Greek default is unlikely to impair money-market funds," said Greg McBride, senior financial analyst at Bankrate.com.

What does the Greek crisis mean for the U.S. dollar?

The euro weakened over the last two months as investors sought safe haven in the U.S. dollar. But the trend reversed itself dramatically last week as the euro rallied strongly on the rising prospects for an aid package.

A weakening dollar could stoke inflationary pressure by increasing the price of crude oil and other goods imported from Europe. But it also could spur the U.S. economy by making American goods cheaper overseas, a key factor that has given the domestic economy a greater lift than expected in the last year.

What would be the effect on U.S. consumers and investors if a Greek default is averted?

"You're not going to see much impact if Greece doesn't default," McBride said. "It just becomes a non-issue."

walter.hamilton@latimes.com

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