The Greek debt crisis has ignited fears of a renewed global credit crunch – possibly worse than the one caused by the collapse of Wall Street's investment banking powerhouse Lehman Brothers.
The country's severe financial and political problems, compounded by concerns about the pace of economic recovery in the United States, have sent financial markets reeling around the world.
Shares have tumbled in recent days and the euro has followed suit. Meanwhile, thousands of protesters have taken to the streets in Athens to demonstrate against austerity measures introduced by Prime Minister George Papandreou, who now plans to reshuffle his cabinet and seek a vote of confidence in parliament.
On top of all this, European Union leaders are divided over a second bailout for debt-ridden Greece.
The situation is serious, experts agree.
"This is a major crisis not only for the eurozone but for the world financial system," said Falko Fecht, a professor of economic and banking policy at the Wiesbaden-based European Business School (EBS).
"Even though the outstanding debt of Greece is small as seen from a global perspective, it has the potential to trigger quite severe contagion effects that have the potential to bring down large parts of the global financial system again and lead to an eruption very similar to Lehman Brothers," Fecht told Deutsche Welle
Greece needs to pass a round of austerity measures by the end of the month if it is to secure new loans from the International Monetary Fund and the European Union. The cutbacks are deeply unpopular with Greeks, many of whom have already suffered significant salary and pension cuts.
"All the programs are running behind schedule," said Niels Christoffer Thygesen, a professor emeritus of economics at the University of Copenhagen. "Taxes are coming in too slowly and privatization hasn't really started. These measures and the additional expenditure cuts are being corrected, but under great political turmoil."
Many question whether Greece will be able to dodge a default on its debts. Numerous investors have increased their bets that the country will fail.
Athens' situation deteriorated even further when the Standard & Poor's rating agency slapped the country with the world's lowest credit rating – CCC.
At the same time, Moody's, another rating agency, put three big French banks on review for downgrades because of all the money they've lent to the Greek government and nation's banks. Not surprisingly, France is pushing for a solution that would avoid a Greek default.
The European Central Bank, which is generally opposed to schemes that are not purely voluntary, has warned that it would be a huge mistake if Greece were allowed to miss its debt repayments either by delaying them or discounting the amounts due. The bank has also taken this position, in part, because of its own exposure, estimated to be between 130 billion and 140 billion euros (as much as $200 billion).
That means the ECB is butting heads with Germany. The biggest economy in the 17-member eurozone is demanding the private sector accept some form of loss on their Greek bonds.
Many economists side with German Finance Minister Wolfgang Schäuble, who is pushing hard for private sector involvement.
"Bringing in private creditors is correct, in principle," Thygesen said.
EBS economics professor Fecht said the voluntary exchange of the current bonds into longer-term instruments, as suggested by Schäuble, "is an option that one should seriously consider: It is a good way to reduce pressure from financial markets while keeping up pressure on Greece to push through financial reforms."
Damned if you do…
Marco Annunziata, chief economist at General Electric, said the hard question is how to share the cost of supporting Greece for a longer period of time until the structural reforms take effect.
"It is understandable that taxpayers in Germany and other EU countries are reluctant to contribute and that some governments are therefore pushing for private creditors to share the burden," he told Deutsche Welle.
"We have to remember, however, that a large portion of Greek debt is held by banks in other eurozone countries. If these banks suffer a loss on their holdings of Greek debt and then need to be recapitalized, the burden will still fall on the taxpayers."
Few experts expect Greece to take the draconian step to exit the eurozone - but that doesn't mean they're not worried about the currency union.
"This is a very difficult time for the eurozone," said Alcidi Cinzia, a research fellow at the Centre for European Policy Studies (CEPS) in Brussels. "I believe it can still be sustainable but this will depend crucially on how the exit from the current crisis is handled."
Annunziata is convinced that the eurozone will survive the crisis and that no country will leave it. "If a country were to leave, the benefits of an exchange rate depreciation would be offset by higher inflation, higher interest rates on debt and financial instability," he said.
"And since there would be spillover effects on many other countries, this would not be in the interest of any single country and not in the interest of the eurozone as a whole."
Time to step up
As for the role of Germany, Annunziata, who was chief economist at UniCredit Group before joining General Electric, sees the country as a leader, not least because of its status as the largest contributor to the rescue programs.
"I believe Germany is right to push for stronger fiscal discipline within the eurozone, and for stronger fiscal rules," he said. "At the same time, however, the German government and its partners should be aware of the risk that delaying a solution to the Greek crisis can exacerbate tensions in financial markets."
Thygesen, who was an independent member of the Delors Committee on Economic and Monetary Union, admits the situation is all but satisfying. "Some of my economist colleagues are impatient," he noted. "They say (European leaders) are just kicking the can down the road and hoping for the best."
The Danish economist said he is "still sufficiently hopeful" that an agreement can be reached "when the Greeks accept there is no satisfactory alternative but to follow the adjustment program."
Author: John Blau
Editor: Sam Edmonds