Testing the Euro Zone's Family Ties

Government debt is supposed to be safer than corporate bonds, but in these shaky times investors are starting to worry about a wave of sovereign debt defaults in, of all places, Western Europe.

Investors have been dumping Greek bonds since the newly elected government revealed that the deficit will soar to over 12% of GDP this year, well above forecasts. Ratings agencies have been downgrading Greek debt and yesterday S&P and other agencies warned Spain and Portugal of possible ratings cuts, raising fears of a sovereign debt crisis spreading across the continent. Those concerns have hammered the euro, sending it below $1.50 for the first time in weeks, and it’s dragging down financials stocks and markets broadly in Europe.

Some analysts say the Greek credit downgrades were long overdue. Greece’s data on its debt and deficit was widely known to be a “fabrication,” says Stephen Pope, chief global strategist for Cantor Fitzgerald in London. The country’s finances have long been a mess, with heavy debts owed to foreign private-sector contractors. And Greece hasn’t implemented austere budget cuts that would shrink its deficit to a more manageable level--a move analysts say is necessary, even if it would spark rioting in Athens. Says Pope, Greece’s BBB+ credit rating still looks “more airbrushed than a picture of Twiggy.”

Of course, the European Union will probably step in to prevent a Greek default. Europe’s wealthy nations bailed out Iceland in 2008, saddling them with losses of $74 billion, and analysts figure the EU may have no choice but to prop up Greece. Without a bailout package, countries such as Spain, Portugal, Ireland and even Italy could start to see attacks on their sovereign debt, spawning another Euro currency crisis. “If Greece goes,” says Pope, “look for a feeding frenzy to begin.”

This article is an excerpt from our Early Bird markets story, which was originally published the morning of Dec. 17.