Stock market's next act may hinge on Greek drama in June

Elections will be crucial to U.S., global economy

May 30, 2012|Gail MarksJarvis
  • Traders work on the floor of the New York Stock Exchange, May 29, 2012.
Traders work on the floor of the New York Stock Exchange, May 29, 2012. (Brendan McDermid, Reuters)

As strange as this might sound to an American, the well-being of your 401(k) in June will largely depend on the national elections held in Greece on June 17.

While tiny Greece can't make or break an individual's investments by itself, the country's fate is pivotal for the health of Europe and the global economy. In its elections, the Greeks could choose leaders who will calm the fears that have been tugging at your investments or ignite a sequence of events that could set off a banking panic as traumatic as the Lehman Brothers collapse in the financial crisis of 2008.

Depending on the outcome, the U.S. could experience another recession and another plunge in the stock market, or by mid-June investors in the U.S. and around the world could be breathing easier and enjoying a hefty relief rally.

Greek elections won't end the European debt crisis or guarantee that in the months ahead investors won't end up fretting again about European banks collapsing and setting off a global financial crisis. But the elections could ease the pressure for a while — perhaps long enough for European countries to agree on controversial solutions.

Here are some potential scenarios analysts think could be rooted in the elections:

The calming scenario. Greeks elect a government that goes along with the painful austerity measures other countries are imposing in exchange for giving the country loans.

Without aid, Greece cannot pay its debts or cover the cost of operating. And if it can't pay its debts, banks and other lenders holding Greek bonds won't get paid. In other words, they will endure losses and, ultimately, banks could collapse, potentially setting off a broader crisis that eventually could touch America.

If the Greeks vote for austerity, the pain will be intense for Greece, but the rest of the world gets some breathing room.

Fear and contagion. Greeks elect leaders who say "no" to the painful austerity requirements European leaders have imposed. That could lay the groundwork for contagion.

If Greece balks at the austerity requirements imposed by European leaders and decides instead to live without aid, default on its loans and leave the euro, investors might worry that countries such as Portugal, Ireland, Spain and Italy might do the same. Worried investors would then make those countries pay oppressively high interest rates in order to borrow money. In fact, their costs of borrowing money already have risen sharply.

Eventually, the cost of debt and austerity could get too high for the countries to bear and the bailouts too difficult for Europe to finance. As a result, these other countries could default on their bonds. Then more banks would have sizable losses or fear them. They would try to survive by holding on to cash instead of making loans.

Because banks are like a heart, pumping blood into the economy, a lot of bank failures or crippled banks could be catastrophic — starving the economy of money the way the U.S. financial crisis did. A deep recession would likely result.

Or as economist Craig Alexander, economist with TD Economics, put it, if Greece leaves the euro, "it would have global financial ramifications that could range from severe to catastrophic."

A run on the banks. Some people with accounts in Greek banks, and in banks in Spain and Italy, haven't been waiting for banks to fail and the governments to start printing their own money. Individuals are being pre-emptive — pulling money out of banks rather than taking a chance that some day they won't be able to get euros out of their accounts. That, of course, puts an additional strain on bank finances.

If Greece rejects austerity through the election process, and consequently stops getting aid from Europe and has to start printing its own money, that money will likely be drachmas, not euros. In other words, people with money in banks could eventually find out they can only get drachmas out of their Greek accounts. So the value of their savings would be half of what they assume it to be.

As a result, if they want to buy something in euros, they wouldn't be able to afford what they used to buy. A decline in purchasing power and lifestyles would be the outcome.

JPMorgan strategist Thomas Lee envisions the process and shock for individuals with bank accounts this way: "Essentially, Greece would one day restrict all commerce out of the country and rename the Greek euro a new currency. This would obviously cause massive economic distress to the local economy."

Citigroup analyst Matt King estimates that Italy lost at least $160 billion in bank deposits and government and corporate bond sales by foreigners in 2011. He estimates $100 billion out of Spain and says capital flight out of Greece, Ireland and Portugal isn't reversing, even when markets have been rallying.

"A Greek exit would almost certainly significantly accelerate the time scale and increase the amounts of these outflows," he said.