As Greece Teeters Closer To Default, Investors Bet On Political Will For Preserving European Union

06/20/2011 07:18 pm ET | Updated Aug 20, 2011

As Greece teetered closer to the precipice of government default, investors appeared to come to the conclusion on Monday that although the troubled country probably will receive help from Europe and avoid a sudden default, it will be forced to restructure its debt soon.

As the cost of insuring Greek debt continued to skyrocket on Monday, the euro wavered; U.S. markets modestly rose; and European markets modestly fell. As traders weighed the news of Europe's ultimatum to Greece to slash its budget by July 3 or risk defaulting -- just as Greece's political leadership faces a vote of no confidence tomorrow -- the markets ultimately wagered that even though Greece probably will not be able to pay back its investors in full, it probably will be able to avoid a sudden default that would pose an existential threat to the European Union.

"They [European leaders] do not want this grand experiment -- bringing together Europe into a single common market and single currency -- they do not want that to fail," said Nariman Behravesh, chief economist at IHS Global Insight. "That is the thing they are all trying to avoid, and they will."

"It's amazing how impending crisis can focus minds," Behravesh added. "There are ways out. It does not have to end in a meltdown. It doesn't. Europe is a rich region; they've got the money. The issue is the political part."

Mark Vitner, a senior economist at Wells Fargo, called the situation a game of chicken between the Greeks and the large European banks holding Greek debt. "It will come to whatever the ultimate deadline is; it always seems to," he said.

Some economists expressed less confidence in Greece's ability to pull itself away from the brink of default, which could threaten the American economic recovery.

Jay Bryson, a global economist at Wells Fargo, said that there is a "50/50" chance that Greece will pass its required austerity measures and restructure its debt in a less damaging way. If the country does not implement sufficient budget cuts, it will be forced to default within the next couple of months.

Bryson said that it makes sense for European leaders to force the issue now. "If these guys [Greek leaders] really truly are insolvent, you're probably better off restructuring the debt at this point than giving them even more money," he said.

Gary Burtless, an economist at the Brookings Institution, pointed to the very high cost of insuring Greek debt as a sign that investors fear that the government will not be able to pay its obligations back in full. "There's a very widespread fear in the market that these bonds are not going to be repaid on time and at the interest rate that is stated on the face of the bonds," Burtless said.

Scott MacDonald, head of research at Aladdin Capital LLC, said: "The market expects there to be a huge discount to Greek paper": an expectation that could become a self-fulfilling prophecy.

"You reach a stage where it becomes very, very difficult to climb back off the ledge, and I don't know if we can climb back off the ledge here," MacDonald said. "It depends on how they default."

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