Veering towards Greek default

The mood in global markets turned grim overnight, as investors fretted that rescue plans for debt-laden Greece were fraying, and that the country was veering towards a debt default.

On Sunday night, the Greek parliament approved tough new austerity measures as the price for a second €130 billion ($US170.6 billion) bailout. As part of the new bailout package, the country's private sector lenders are being pressured to "voluntarily” agree to write off half of the €200 billion they have lent the debt-riddled country. But hedge funds, who now hold an estimated €70 billion of Greek bonds, are holding out.

Overnight, the German financial newspaper Handelsblatt reported that some central bankers now expect that Greece will fail to get enough private lenders to agree to a "voluntary” debt restructuring that would allow the country to avoid a technical default.

According to the report, if Greece fails to get enough support from private lenders for the "voluntary” debt deal, the Greek government will have little choice but to change the terms of its loans in order to force those lenders who are holding out to take mandatory writedowns. But forcing lenders to take a loss would likely cause credit rating agencies to declare an event of default on Greek debt, which would trigger credit default swaps – which are a form of insurance on Greek bonds.

There are widespread fears that this could unleash a massive disruption in financial markets as Greek bondholders turn to banks and insurance companies and demand that they pay out on the huge numbers of CDS contracts that they have written. At the same time, bond yields for other debt-laden eurozone countries are likely to soar, as panicked investors dump their bonds, fearing that they may also end up defaulting.

At the same time, investors were unnerved by the decision of eurozone finance ministers to postpone a meeting scheduled for today, which had been expected to give the green light to Greece's crucial €130 billion bailout.

Several reasons were cited for the delay. First of all, Athens needed extra time to find a further €325 million in spending cuts to close a gap in this year's budget. Also, the eurozone has yet to receive a letter from the leaders of Greece's main political parties promising that they'll stick to the terms of the tough austerity program after the April general election. Eurozone officials were deeply concerned when Antonis Samaris, the leader of the centre-right New Democracy party who is widely tipped to become Greece's next prime minister, vowed that he would renegotiate the deal if he won April's election.

But the meeting was also postponed for other, more troubling, reasons. It's now clear there is a growing rift within the eurozone over whether Athens deserves a second bailout. Several eurozone countries – notably Germany, Finland and the Netherlands – have lost faith in Greece because of the country's continuing failure to deliver on its promises to deliver on spending cuts and to push through with tough reforms. These countries are now questioning whether it's worth squandering even more taxpayer money to prop up a country which is not prepared to help itself.

There's also disagreement over whether the European Central Bank should be forced to take a writedown on the estimated €50 billion of Greek bonds it bought as it tried to stop Greek interest rates from soaring. The ECB is fiercely opposed to writing down the value of its Greek debt, because it fears that other countries, such as Portugal and Spain, will want a similar treatment. But many experts argue that a writedown in the ECB's Greek bonds will be necessary to reduce Greece's debt burden to a sustainable level.

But even if the ECB agrees to write down the value of its Greek bonds, many believe that Greece's second bailout is doomed to failure. The Greek economy has been ravaged by austerity, with figures released overnight showing that it contracted by 7 per cent in the final three months of 2011 compared with the same period a year earlier. Further austerity will only exacerbate the country's pain.