Courtesy of Wikimedia.org

Cour­tesy of Wikimedia.org

For the past sev­er­al weeks, atten­tion has focused on the debt cri­sis plagu­ing Greece and the con­tentious nego­ti­a­tions with its cred­i­tors. The sit­u­a­tion in Europe is prob­a­bly affect­ing your port­fo­lio to some degree right now. But how can the prob­lems of a coun­try so small and so far away cre­ate such tur­moil in the world’s finan­cial mar­kets? It may be help­ful to con­sid­er how Greece got to this point, what might hap­pen from here, and, equal­ly impor­tant, how events in Europe might impact the mar­kets in gen­er­al and investors specif­i­cal­ly.

How did this happen?

Greece, like most major economies, bor­rowed mon­ey to help pay its bills. How­ev­er, the Greek econ­o­my was hit hard by the reces­sion of 2008–2009. To make mat­ters worse, in Octo­ber 2009, the gov­ern­ment admit­ted that the nation’s deficit had been under­stat­ed for years, rais­ing seri­ous con­cerns about the sound­ness of the coun­try’s finances. As a con­se­quence, inter­est rates on Greece’s sov­er­eign debt spiked and the gov­ern­ment was essen­tial­ly unable to bor­row on inter­na­tion­al mar­kets, as investors feared they might not get their mon­ey back.

By the spring of 2010, Greece was run­ning out of mon­ey and head­ing toward bank­rupt­cy. In an attempt to avert fur­ther finan­cial cri­sis, the Euro­pean Cen­tral Bank (ECB), the Inter­na­tion­al Mon­e­tary Fund (IMF), and the Euro­pean Com­mis­sion (EC) issued the first of two inter­na­tion­al bailouts for Greece total­ing more than 240 bil­lion euros, or in excess of $260 bil­lion at cur­rent exchange rates. As a con­di­tion of the loans, lenders demand­ed strict aus­ter­i­ty mea­sures intend­ed to cut Greece’s bud­get deficit and debt bur­den.

The bailouts and aus­ter­i­ty mea­sures were intend­ed to pro­vide time for Greece to sta­bi­lize its finances. Unfor­tu­nate­ly, the eco­nom­ic prob­lems that plagued Greece haven’t van­ished. The coun­try’s GDP has shrunk and unem­ploy­ment is above 25%. By the end of 2014, the debt-to-GDP ratio for Greece had climbed to over 170%–far exceed­ing any oth­er coun­try in the euro­zone. As a con­di­tion for more bailout funds, Greece’s cred­i­tors demand­ed addi­tion­al bud­getary require­ments. How­ev­er, many Greeks, includ­ing the coun­try’s rul­ing par­ty, Syriza, blame the pri­or aus­ter­i­ty mea­sures for much of the coun­try’s cur­rent eco­nom­ic hard­ships.

With no agree­ment in place, loans were stopped and Greece became the first devel­oped coun­try to default on a loan pay­ment to the IMF. In addi­tion, Greek banks were essen­tial­ly closed to avoid a large scale run on what lit­tle cash was avail­able, allow­ing depos­i­tors access to no more than 60 euros ($66) per day. On July 5, in response to a spe­cial ref­er­en­dum called by Greek Prime Min­is­ter Alex­is Tsipras on whether to accept the cred­i­tors’ lat­est aus­ter­i­ty require­ments, Greek cit­i­zens vot­ed a resound­ing “no.” With mon­ey quick­ly run­ning out, what will Greece do to main­tain its sol­ven­cy?

What are the possible scenarios?

Greece and its cred­i­tors could reach an accord, putting a new agree­ment in place that would pro­vide the coun­try with more bailout funds, pre­sum­ably includ­ing emer­gency monies allow­ing banks to reopen. The poten­tial terms of such a deal are open to spec­u­la­tion, but they could like­ly include some debt reduc­tion cou­pled with a mea­sure of gov­ern­ment reform.

Oth­er­wise, short of an influx of cash, Greek banks could soon run out of mon­ey. This would like­ly force the gov­ern­ment to start print­ing its own cur­ren­cy by rein­tro­duc­ing the drach­ma while impos­ing heav­ier cap­i­tal con­trols on lend­ing and lim­it­ing access to depos­i­tor funds. In this sce­nario, Greece could exit the euro­zone (“Grex­it”), which no coun­try has done since the euro­zone’s incep­tion in 1999. In any case, Greek debt would be con­vert­ed from euros to drach­mas, the val­ue of which would like­ly plum­met, caus­ing infla­tion to soar, dri­ving down pur­chas­ing pow­er. Greek bank depos­i­tors who had euros in their accounts would now have drach­mas, one for one, but they would be worth sub­stan­tial­ly less than the euro.

Could a Greek default cause a financial crisis?

Most banks and finan­cial insti­tu­tions should be able to weath­er loss­es relat­ed to a poten­tial Greek default. Much of Greece’s debt is held by gov­ern­ments and the IMF, as opposed to pri­vate cred­i­tors and banks, so they may have lit­tle expo­sure to what hap­pens with the coun­try.

In addi­tion, oth­er coun­tries that have faced eco­nom­ic hard­ships in the past, such as Por­tu­gal, Spain, and Italy, have tak­en steps to reform their economies and are much less sus­cep­ti­ble to bond mar­ket con­ta­gion than they may have been in years past.

What about my portfolio?

Suf­fice it to say, per­for­mance of the stock mar­kets may be influ­enced by a litany of fac­tors. It’s unlike­ly that the U.S. mar­kets in par­tic­u­lar will suf­fer long-term neg­a­tive effects sole­ly due to the Greek finan­cial cri­sis. In any case, dur­ing peri­ods of mar­ket volatil­i­ty, it’s always a good time to review your port­fo­lio with your finan­cial pro­fes­sion­al.

Gen­er­al­ly speak­ing, finan­cial mar­kets hate uncer­tain­ty, and the cur­rent sit­u­a­tion has con­tributed to mar­ket volatil­i­ty. A volatile mar­ket, whether due to glob­al trou­bles or domes­tic influ­ences, can make it hard to pro­tect your invest­ments through diver­si­fi­ca­tion alone, which can’t guar­an­tee a prof­it or pro­tect against poten­tial loss. So it might be worth explor­ing ways to hedge your port­fo­lio’s expo­sure to pos­si­ble mar­ket volatil­i­ty. Uncer­tain­ty in the finan­cial mar­kets could per­sist for a while, but it’s impor­tant to keep it in per­spec­tive. Though you should mon­i­tor the sit­u­a­tion, don’t let every twist and turn derail a care­ful­ly con­struct­ed invest­ment game plan.

 

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