Federal Reserve Chairman Ben S. Bernanke said a default by Greece would have little impact on U.S. banks, which aren't "significantly exposed" to European nations struggling to meet debt payments.
"We have asked the banks to essentially do stress tests and ask, looking at all their positions, all their hedges, what would the effect on their capital be if -- if Greece defaulted," Bernanke said to reporters today at a press conference after a meeting of the Federal Open Market Committee. "The answer is that the effects are very small."
But the fact is, because of derivatives (essentially, insurance contracts that are used to bet on a default), no one really knows what the effects of a Greek default would be, least of all Ben Bernanke.
It’s the $616 billion question: Does the euro crisis have a hidden A.I.G.? No one seems to be sure, in large part because the world of derivatives is so murky, but the possibility that some company out there may have insured billions of dollars of European debt has added a new wrinkle to the sovereign default debate...
...The looming question is whether these contracts — which insure against possibilities like a Greek default — are concentrated in the hands of a few companies, and if these companies will be able to pay out billions of dollars to cover losses during a default. If there were a single company standing behind many of these contracts, that company would be akin to the American International Group of the euro crisis. The American insurer needed a $182 billion federal bailout during the financial crisis because it had insured the performance of mortgage bonds through derivatives and couldn’t pay on all of them...
...Even regulators seem unsure of whether a Greek default would reveal such concentrated risk in the hands of just a few companies. Spokeswomen for the central banks of both Europe and the United States would not say whether their researchers had studied holdings of such contracts among nonbank entities like insurance companies and hedge funds — and they would not say what would occur among large players if Greece or another European country defaulted...
The head of the world's most powerful bond company believes a default by Greece is a fait accompli.
Mohamed El-Erian, chief executive officer of the Pacific Investment Management Co. (PIMCO), has predicted that Greece and other similarly afflicted European economies will default on their debts... His viewpoint that default is the only option for Greece to escape its debt crisis comes shortly after the Greek government on Tuesday won a crucial vote of confidence. The vote increases the government's chances of securing additional financial aid from the European Union and the International Monetary Fund (IMF) to avoid the eurozone's first sovereign debt default.
This is very, very bad news for the economy. Because Ben Bernanke has an almost perfect record when it comes to predicting economic events. Perfect in that he never gets it right.
• July 2005: There's no housing bubble
• February 2007: No indication that subprime mortgages will affect the rest of the housing market
• July 2007: The U.S. economy will strengthen in 2008
• March 2009: Expect a booming recovery in 2010
In fact, it is impossible to predict what will happen, but one can surmise a sovereign default by Greece will be anything but pleasant.
A default will weaken banks, which could cause bank runs and weakness in the Euro, which could undermine the EU itself, which would weaken other countries on the edge like Ireland and Spain, which could default themselves...
Think Lehman Brothers, only bigger and with more socialists involved.