Greek debt crisis: Everything you need to know
Adam Shell, USA TODAY
(Photo: Angelos Tzortzinis, AFP/Getty Images)
Greece
must come up with a loan payment of $1.8 billion to the International
Monetary Fund by Tuesday to avoid a default. Greece and its creditors
are still squabbling over a final deal as the clock ticks and next
week's deadline looms.
Here is what you need to know:
Why is Greece in debt?
Just
like a household that spends more money each month than it brings in,
Greece has piled up a mountain of debt by spending beyond its means.
"Constant
government borrowing to fund promises by politicians" has caused
Greece's cash crunch, says David Kotok, chief investment officer at
Cumberland Advisors.
Making
matters worse, for the purposes of paying out benefits, Greece has a
retirement age of 57. That's low compared to the U.S., where retirees
can start taking benefits at age 62. While retiring early is good for
Greek workers, it creates a major financial burden on the government.
Tax evasion in Greece is also legendary, and when taxpayers dodge their
obligations it means less revenue for the debt-strapped government.
Who loaned them money? Why?
At
first, Athens borrowed billions of dollars from European banks to make
ends meet (those same banks agreed to a 50% haircut on those loans in
October 2011). But Greece couldn't come up with the cash to pay off
those loans, further exacerbating the debt problem. Greece was no longer
able to raise funds from the public markets as investors feared they
wouldn't get their money back if they lent money to Greece.
With
Greece on a path towards bankruptcy in early 2010 — and the threat of a
new financial crisis looming — the country got its first of two
international bailouts that would end up totaling 240 billion euros
($268.8 billion in U.S. dollars at current exchange rates) from the
so-called "troika" — the European Central Bank , the International
Monetary Fund and the European Commission. The bulk of the money Athens
owes today is to the troika, and not to European banks.
Why hasn't Greece paid the troika back?
The
bailout terms were stringent. The "austerity" plan meant less spending,
higher taxes, a crackdown on tax evasion and other measures designed to
get Greece's finances back on track. But Greece still couldn't come up
with the funds to pay its bills on its own.
As
a result, Greece's financial situation worsened. Its unemployment rate
is above 25% and its GDP has fallen by roughly 30% since 2008, according
to World Bank data. Greece's debt is nearing 200% of GDP.
"(Greece) never made policy changes," says Kotok. "They kept doing business as usual."
The
bottom line: most of the bailout money Greece receives is used to repay
loans from its creditors. And it is virtually impossible for Greece to
pay down its enormous debt when the economy is underperforming.
What happens if Greece doesn't pay back the loans?
If
Greece defaults, its economy will contract further and jobs will be
harder to come by. Uncertainty about the future will skyrocket. Greek
depositors will have trouble getting their money out of banks.
Government services will become scarce. And voters could find themselves
going to the polls to elect new leaders.
It
would also mark the first major advanced economy to renege on a payment
to the IMF. Usually, the IMF affords a 30-day grace period before it
declares technical default, although IMF Managing Director Christine
Lagarde has said Greece will get no such grace period.
A
default would also likely mean that the ECB would cut off its emergency
cash infusions to Greek banks. That could result in runs on Greek banks
(depositors have been yanking cash out of banks there for weeks).
Capital controls, or restrictions placed on how much cash depositors can
access from their accounts, are also likely.
"Greece
won't get a loan at palatable terms, forcing immediate and severe
adjustments," says Axel Merk, chief investment officer at Merk
Investments. "In addition, Greek banks are likely to collapse, crippling
what's left of the economy. Beyond that, it's all speculation."
Greece will likely issue its own currency, too, Merk adds, but it doesn't mean people will accept it.
Financial
markets will probably react negatively, although it's unclear on how
big the negative fallout will be. Investors will quickly try to
determine if a Greek default leads to financial contagion, or spreads to
other markets around the globe. Currently, the consensus is that Greece
does not pose a "systemic" risk to the system.
What's at stake for the European economy?
Opinions differ to how a default will affect the European economy.
"Not much, this is Greece's problem," says Merk. "Indeed, clarity would be helpful, as one could move forward."
Despite
Greek's woes, the eurozone economy is starting to firm up, bolstered in
large part by the ECB's government bond-buying program designed to
reflate the economy by keeping rates low and bolstering economic
activity. The eurozone, a 19-nation economic and currency bloc, has
finally climbed out of recession and grew 0.4% in the first quarter of
2015.
Given
that Greece's economy is centered mainly around tourism, coupled with
the fact that the bulk of its debt is no longer held by European banks
and the ECB now has backstop tools if turbulence occurs, a default is
not expected to bring the eurozone economy to its knees.
Offering
a differing opinion, Kotok counters that there are still many
uncertainties related to how markets will react to a Greek default. "The
rest of Europe is a big uncertainty," says Kotok. "That is the unknown
risk."
What's at stake for Greece?
"Everything," Merk warns. "They can choose between making a tough or a horrible choice. Both are painful."
Greece's
role as a member of the 19-nation euro is at stake. There is a chance
that it will have to exit from the euro. What's more, if Greece fails to
strike a deal for more bailout funds, it is likely that the financial
pain and economic challenges will become even greater, creating a great
burden on its citizens.
Contributing: Kim Hjelmgaard
Maury
Harris, chief economist at UBS, discusses how Greek debt may impact the
United States markets and what's different in this round of debt
negotiations. Bloomberg
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